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This Vanguard Fund Is Conservatism at Its Best

Vanguard Wellesley Income's strong leadership, effective process, and low fees support the fund's Gold rating.

The following is our latest Fund Analyst Report for Vanguard Wellesley Income Fund 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.

Strong leadership supports Vanguard Wellesley's Morningstar Analyst Rating of Gold. That hasn't changed since the early-2017 promotion of credit specialists Mike Stack and Loren Moran to comanagers alongside veteran lead bond manager John Keogh. Stack has 35 years of industry experience and Moran about 15. While Keogh has no imminent plans to retire, either Stack or Moran are well-equipped to take over Keogh's role of top-down risk assessment and yield-curve positioning when he steps down.

Longest-tenured manager Michael Reckmeyer still leads the fund's equity side. He works as part of a seasoned seven-person team and has access to a deep bench of industry analysts.

The fund uses a conservative but effective process. Reckmeyer invests the roughly 35% equity sleeve in above-average dividend-payers, like

The fund is prone to lag when interest rates spike, as in 2016's second half, but it has a stellar record in multiyear periods. Through April 2017, its trailing returns of three years or more all ranked in the category's top decile.

The fund has also shown it can weather repeated interest-rate increases by the Fed. Between June 2004 and May 2007, the Fed raised rates by 25 basis points on 17 separate occasions, hiking the overnight lending rate to 5.25% from 1.00%. 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 strategy inspire confidence for the long term.

Process Pillar: Positive | Alec Lucas, Ph.D. 05/30/2017 This fund receives a Positive Process Pillar rating for its balanced approach to providing income, capital appreciation, and downside protection. The managers invest 60%-65% of assets in investment-grade bonds, and 35%-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 tends to generate 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 a stock portfolio whose return on assets ranks in the allocation--30% to 50% equity category's top quintile.

Lead fixed-income manager John Keogh and comanagers Mike Stack and Loren Moran draw on Wellington Management's extensive credit research to find bonds offering yields that compensate for their risks. They also buy agency-issued mortgage-backed, asset-backed, and taxable municipal securities. The team 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%-65% of assets, has steadily become more diversified, growing from around 300 bonds in late 2009 to nearly 1,000 in April 2017. 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 2017, that index had a 6.7-year duration versus 6.5 years for the fund. In contrast, the allocation--30% to 50% equity category median was 4.5 years.

The roughly 35%-40% equity portion is stashed in 50-60 large-cap dividend-paying stocks. Sector weightings tend to stay close to the FTSE High Dividend Yield Index's. The equity portfolio's most distinctive sector position currently is a 11.1% energy stake, versus the index's 9.3%. Manager Michael Reckmeyer also departs from his U.S.-focused bogy by investing in foreign names that pay stout dividends, like Canada's

Performance Pillar: Positive | Alec Lucas, Ph.D. 05/30/2017 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 7.8% annualized gain through April 2017 beat its customized benchmark (weighted 65% in the Barclays U.S. Credit A or Better Index, 35% in the FTSE High Dividend Yield Index) by 83 basis points and placed fourth out of about 100 allocation--30% to 50% equity category peers, while its Morningstar Risk-Adjusted Return placed second.

A strong showing is typical here. Dating back to its July 1970 inception, the fund's 9.8% annualized gain through April 2017 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 can lag when interest rates spike. That happened during 2013's taper tantrum and more recently in 2016's second half, when the 10-year Treasury's yield shot up about 120 basis points. Despite trailing most peers during both of those periods, the fund still outperformed in each of those calendar years, including 2016's top-quartile finish. Although more rate-sensitive than most peers, the fund's management and proven strategy inspire confidence for the long term.

People Pillar

: Positive | Alec Lucas, Ph.D. 05/30/2017

This fund benefits from subadvisor Wellington Management's strong leadership and ample resources, earning it a Positive People rating. John Keogh has led the bond side's 65% slice of the portfolio since July 2008, and he uses the same strategy for the fixed-income portion of

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

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 | 12/12/2016 Vanguard has one of the mutual fund industry's strongest corporate cultures and earns a Positive Parent rating. Its consistent messages to investors to keep costs low, diversify, and stay the course are reflected in the firm's own behavior. Vanguard's U.S. fundholders own the firm through small investments by each mutual fund, mitigating 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 are greater than 70%--high among large, diversified fund families.

Over the past year, the firm has collected more than USD 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. Total assets under management now exceed USD 3.3 trillion, giving Vanguard a significant more-than-20% market share across U.S. mutual funds.

Vanguard has been a global player for years but has only more recently turned its focus to growing internationally. The firm is a large player in Australia, where it has the most history, but doesn't yet have the brand recognition and trust it enjoys in the United States in other parts of the world. While non-U.S. funds don't participate in the ownership of Vanguard, the firm's investorcentric culture extends globally.

Price Pillar

: Positive | Alec Lucas, Ph.D. 05/30/2017

Rock-bottom fees earn the fund a Positive Price rating. It's one of the cheapest actively managed conservative-allocation offerings. Just a handful of peers charge levies lower than the retail shares' 0.22%, 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 can offer a competitive yield without taking on additional risks.

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