An Attractive Vanguard Dividend Fund Turns 10

The following is our latest Fund Analyst Report for Vanguard Dividend Appreciation Index Fund VDADX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Vanguard Dividend Appreciation Index has several merits that lead to a Morningstar Analyst Rating of Gold. The fund is backed by Vanguard's massive indexing operation, which is topnotch in the industry. Like most Vanguard funds, it benefits from low fees. The fund is priced competitively relative to other strategic-beta offerings, which are typically a little pricier than standard index funds. Investors pay 19 basis points with a $3,000 minimum investment, 9 basis points for the Admiral shares with a $10,000 investment, or 10 basis points for the exchange-traded fund.

The fund tracks the Nasdaq US Dividend Achievers Select Index, which includes stocks that have increased their dividend for at least 10 consecutive years but excludes REITs and other companies that have low potential for dividend growth. Unsurprisingly, the fund has seen a drop in its energy exposure as oil prices have slid, from almost 10% of assets in March 2014 to 1% in March 2016.

The fund's focus on firms that are financially healthy enough to grow their payouts favors highly profitable companies with durable competitive advantages. Relative to the S&P 500, the fund sports higher returns on equity, assets, and invested capital. Those traits can come at a premium, and the fund does look pricier than the S&P 500 on traditional metrics such as price/earnings and price/book as of April 2016.

The fund's quality tilt has helped it shine during market downturns. For example, it held up better than the S&P 500 and landed in the top decile of the large-blend Morningstar Category in the rocky market environments of 2008 and 2011.

The fund just hit its 10-year mark on April 27. During that period, it has had low tracking error relative to its stated benchmark while performing competitively relative to its large-blend peers and a subset of funds focused on dividend growth. It hasn't beaten its actively managed sibling,

Process Pillar: Positive The fund tracks the Nasdaq US Dividend Achievers Select Index. This index is a subset of the Nasdaq US Broad Dividend Achievers, which screens for U.S. stocks that have increased their regular dividend for at least 10 consecutive years and meet minimum liquidity requirements. From this broader list of stocks, the Dividend Achievers Select Index excludes REITs and limited partnerships and applies other proprietary screens to arrive at a final list of 140-190 constituents. While those additional screens are not disclosed in detail, they appear to look for dividend sustainability and exclude companies that have low potential for dividend growth. The results are market-cap-weighted, but stocks typically don't comprise more than 4% of the index. The index is reconstituted annually.

The fund follows a full replication strategy, holding each of the stocks in the index at precise index weightings. About $21 billion of the fund’s $25 billion in assets are held in the fund’s ETF share class, which helps limit the potential impact of fund flows on the tax efficiency of the fund. The fund has never issued a capital gain. Turnover has averaged 13% during the past five years, well below the 60% average of the large-blend Morningstar Category during that period. This approach results in a high-quality, low-turnover portfolio and earns a Positive Process rating.

Whereas most dividend-themed funds end up with a value tilt and a higher dividend yield, this fund falls in the large-blend Morningstar Category and has a dividend yield in the same ballpark as the S&P 500. However, the fund tends to invest in higher-quality companies. For instance, greater percentage of its assets are invested in stocks with Morningstar Economic Moat Ratings of wide (58% as of March 2016 to the S&P 500's 50%). In addition, its holdings have higher returns on invested capital, returns on assets, and returns on equity than the S&P 500. These characteristics usually do not come cheap, and the fund’s valuation metrics are slightly more expensive than the S&P 500, including on a price/earnings, price/book, and price/cash basis.

The fund's 10-year dividend-growth requirement is a tough hurdle to clear. If a company doesn't continue to raise its dividend, it is out for at least a decade. Top holdings currently include

Compared with the S&P 500, the fund has larger stakes in the industrials and consumer staples sectors and less exposure to the financials, energy, and technology sectors. The energy stake has dropped as oil prices have plunged and energy-related companies have come under financial pressure and in some cases cut their dividends, which preclude them from being included here.

Performance Pillar: Positive This fund just hit its 10-year anniversary. The fund has gained 7.1% annualized through late April 2016, lagging its Nasdaq US Dividend Achievers Select Index by a little more than its current expense ratio. It has performed about in line with the S&P 500 during the period and has outperformed about three fourths of a subset of funds focused on dividend growth. It has well exceeded the large-blend category average of 5.5%.

The fund has a desirable risk profile, driven by its high-quality portfolio. It has captured under 80% of the S&P 500's losses in down markets since inception. It has done well relative to peers in periods of market stress, such as 2008 and 2011, when it landed in the category's top decile.

On the flip side, it can lag in bull markets, as is often the case with dividend-focused funds. Its three- and five-year results through April only look average relative to its broad category. However, its long-term risk-adjusted returns remain compelling, warranting a Positive Performance rating.

While the fund has posted strong results relative to many actively managed dividend growth funds, it hasn't topped its Gold-rated sibling, Vanguard Dividend Growth. As an actively managed fund, Vanguard Dividend Growth has more flexibility than this fund, such as buying an attractively priced dividend-paying stock even if it lacks 10 years of dividend increases.

People Pillar:

Positive

Ryan Ludt has been the sole manager on this fund since its 2006 inception. In addition to this fund, he manages

Ludt does not invest in this fund. Manager investment is a tangible sign that a manager’s incentives are aligned with fund shareholders, but low manager investment isn't uncommon for index fund managers. As an index fund manager, Ludt is managing a process rather than making specific stock calls. One way to judge his success is by considering the tracking error of the fund, which has averaged less than 10 basis points during his tenure. This suggests that he has done a great job delivering results consistent with the index.

The experience and depth of Vanguard's indexing team lead to a Positive People rating.

Parent Pillar: Positive | 06/26/2015 Vanguard has one of the mutual fund industry's strongest corporate cultures. Its consistent messages to investors to keep costs low, diversify, and stay the course are illustrated by the firm's own behavior. Vanguard's fundholders own the firm through small investments by each mutual fund, eliminating potential conflicts of interest that can exist at other firms that are serving two masters. Fund performance is strong overall: Over the past three-, five-, and 10-year periods, its Morningstar Success Ratios and Morningstar Risk-Adjusted Success Ratios, which measure what percentage of a firm's funds have both survived and outperformed a given time period, check in at greater than 70%--high among large, diversified fund families.

Over the past year, the firm has collected more than $200 billion in net inflows, thanks in large part to investors’ interest in passive investing. The firm's indexing and ETF prowess, low costs, and success in penetrating the financial-advisor sales channel all have fueled growth. These fund flows, as well as market appreciation, have brought total assets under management to more than $3 trillion. In this number is a nearly 20% market share of U.S. mutual funds, roughly double its next-closest competitor’s.

Fees are very often the industry’s lowest, but manager investment, particularly by index and in-house fixed-income managers, could be better. Vanguard earns a Positive Parent rating.

Price Pillar: Positive The Investor shares have a $3,000 minimum investment and, as of the January 2016 annual report, cost 0.19%. The Admiral shares have a higher minimum of $10,000 but cost just 0.09%. The ETF share class costs 0.10%.

This fund is very competitive on price compared with other large-cap strategic-beta funds, which are typically more expensive than traditional index funds. It earns a Positive Price rating.