This Vanguard Fund Is Conservatism at Its Best

The following is our latest Fund Analyst Report for Vanguard Wellesley Income VWINX. 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 Wellesley’s outperformance over the past year through May 2016 epitomizes why it receives a Morningstar Analyst Rating of Gold. In a rough market, the fund's 4.9% gain edged past its customized benchmark (weighted 65% in the Barclays U.S. Credit A or Better Index, 35% in the FTSE High Dividend Yield Index) and placed in the allocation--30% to 50% equity Morningstar Category's top 1%. The fund's longer-term record is also superior. Since the shared tenure of fixed-income manager John Keogh and equity manager Michael Reckmeyer began in July 2008, the fund’s 8% annualized gain through May 2016 places second out of about 100 peers, while its Morningstar Risk-Adjusted Return places first.

A conservative process has helped here. Reckmeyer invests the roughly 35% equity sleeve in above-average dividend-payers, like

The Fed's late 2015 interest-rate increase of 25 basis points, even if the first of many, shouldn't impair the fund. Granted, it's not immune to interest-rate spikes. When the 10-year Treasury yield shot up about 130 basis points from mid- to late 2013, the fund's 2.7% loss modestly trailed the category norm. Over multiyear periods, however, the fund can still come out ahead. Between June 2004 and May 2007, the Fed raised rates by 25 basis points on 17 separate occasions, hiking the overnight lending rate from 1.00% to 5.25%. During that three-year stretch, the fund's 9% annualized gain beat the category norm by nearly 2 percentage points.

The fund's management and proven strategy inspire confidence for the long term.

Process Pillar: Positive | Alec Lucas 06/13/2016 This fund receives a Positive Process Pillar rating for its balanced approach to providing income, capital appreciation, and downside protection. The managers park 60% to 65% of assets in investment-grade bonds, and 35% to 40% in dividend-paying stocks offering yields higher than that of the S&P 500 and good prospects for growing payouts.

Aided by ultralow expenses, the fund has succeeded over the years at generating an above-average yield by investing in securities of well-capitalized firms. The fund currently derives its top-quartile 2.9% trailing-12-month yield from a bond portfolio with no high-yield bonds and stocks that, on average, have less debt and higher returns on assets than its typical peer's holdings.

Fixed-income manager John Keogh draws on Wellington Management's extensive credit research to find bonds offering yields that compensate for their risks. He also has invested in agency-issued mortgage-backed, asset-backed, and taxable municipal securities. Keogh generally keeps duration within one year of the Barclays U.S. Credit A or Better Bond Index. Equity manager Michael Reckmeyer pays close attention to the fund's dividend requirement and will sell stocks if their yields fall below the S&P 500's. But he also wants the shares of companies that offer decent earnings and dividend growth relative to their valuations.

The fund's fixed-income portfolio, which is 60% to 65% of assets, has steadily become more diversified, growing from around 300 bonds in late 2009 to nearly 900 in April 2016. While the number of bonds has grown, its tilt toward investment-grade securities remains. Most are corporate bonds rated BBB or higher. The fund also keeps a slug of U.S. Treasuries because of their superior liquidity along with cash. In addition, agency mortgage-backed securities have been a recent favorite. They are more liquid than corporates and offer generally more-attractive yields as their loans cannot easily be refinanced. Manager John Keogh can't make big interest-rate bets, but the fund usually sports a longer-than-average duration because he keeps interest-rate sensitivity close to the Barclays U.S. Credit A or Better Bond Index's. In April 2016, that index had a seven-year duration versus 6.9 years for the fund. In contrast, the allocation--30% to 50% equity category median was 4.4 years.

The roughly 35%-40% equity portion is stashed in 50-60 large-cap dividend-paying stocks. Sector weightings tend to stay fairly close to those of the FTSE High Dividend Yield Index. The equity portfolio's biggest position currently is a 14.2% healthcare stake, versus 11.4% for the index. Manager Michael Reckmeyer also departs from his U.S.-focused bogy by investing in foreign names that pay stout dividends, like Britain's National Grid.

Performance Pillar: Positive | Alec Lucas 06/13/2016 Its stellar record earns the fund a Positive Performance Pillar rating. Since managers John Keogh and Michael Reckmeyer began their joint tenure in July 2008, the fund's 8% annualized gain through May 2016 has beaten its customized benchmark (weighted 65% in the Barclays U.S. Credit A or Better Index, 35% in the FTSE High Dividend Yield Index) by a percentage point and places second out of about 100 allocation--30% to 50% equity category peers, while its Morningstar Risk-Adjusted Return places first.

A strong showing is typical here. Dating back to its July 1970 inception, the fund's 9.9% annualized gain through May 2016 is a good return for stocks, let alone a fund with a big bond slug as well. Performance has been consistent, too. The fund has lost money in only six calendar years (1973-74, 1987, 1994, 1999, and 2008).

The fund has flourished during an extended period of primarily falling interest rates dating back to the early 1980s, but it could struggle in relative terms if rates start to rise. That happened in 2013, when the 10-year Treasury yield shot up about 130 basis points from May to early September. Even with gains in its sizable equity portfolio acting as a counterbalance, the fund's 2.7% loss during that time still modestly trailed the category norm. Although it is more rate-sensitive than most peers, the fund's management and proven strategy still inspire confidence for the long term.

People Pillar: Positive | Alec Lucas 06/13/2016 This fund benefits from subadvisor Wellington Management's strong leadership and ample resources, earning it a Positive People Pillar rating. Fixed-income manager John Keogh joined Wellington in 1983 and has led the bond side's 65% slice of the portfolio since July 2008. He uses the same strategy on the fixed-income portion of Vanguard Wellington VWELX, which he's run since July 2006. His team currently includes two credit strategists, one of whom, Michael Stack, serves as the backup portfolio manager here. Stack, like Keogh, has more than 30 years of investment experience, while the other team member, Loren Moran, has more than 10 years of industry experience. They also have access to Wellington's central bench of about 40 fixed-income analysts.

Michael Reckmeyer took over as lead manager of the 35% equity slice in early 2008 and has been a member of the firm's value equity-income team since 1994. He also has run a portion of Vanguard Equity-Income VEIPX since 2008. At Wellington, his eight-person equity team includes five analysts and two other portfolio managers, who average 20-plus years of industry experience. The team also draws upon the firm's 50-plus global industry analysts.

Reckmeyer invests more than $1 million in the fund, as does Keogh in the strategy, when his Vanguard Wellington investment is included.

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 | Alec Lucas 06/13/2016

Rock-bottom fees earn the fund a Positive Price Pillar rating. Indeed, it's one of the cheapest actively managed conservative-allocation offerings. Just a handful of peers charge levies lower than the retail shares' 0.23%, and one of them is

An attractive price tag gives the fund an enormous head start on its competition. High expenses eat into income-oriented funds' yields and can force them to chase dicier, higher-yielding securities to keep pace with rivals. This fund, in contrast, can offer a competitive yield without taking on additional risks.