A Wide-Ranging Income Fund for Contrarians

The following is our latest Fund Analyst Report for Berwyn Income BERIX. 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.

Berwyn Income is a solid option for investors comfortable with a flexible and contrarian conservative-allocation strategy. The fund has a disciplined process, below-average fees, and good downside protection. But a slim team of three, key-person risk, and a Neutral-rated parent in Chartwell slightly offset these positives. On balance, this fund earns a Morningstar Analyst Rating of Bronze.

George Cipolloni and Mark Saylor comanage the fund and receive help from one analyst. That's a small group, especially considering the fund's vast investment universe, which includes dividend-paying global equities across the market-cap spectrum, convertibles, preferreds, investment-grade and high-yield corporate bonds, and Treasuries. But long tenures, marked by strong performance, speak to the managers' skill. Cipolloni has worked on the fund since 2002 and has been a manager since 2006. Saylor has worked alongside Cipolloni since 2007 and has comanaged the fund since January 2014. Over Cipolloni's tenure as manager, the fund has turned in impressive results, outpacing the allocation--15% to 30% equity Morningstar Category by 2.7%, annualized, through November 2018. And over the past decade, the fund's risk-adjusted returns landed in the category's top decile. This performance was achieved through asset allocation and security selection, which illustrates the capabilities of this small team.

The growth-led rally of 2017 was challenging for this value-focused fund, and its 3.9% gain landed in the category's bottom decile. The managers had cut its equity stake to less than 20% of assets and also reduced its exposure to junk bonds, areas that generated strong returns that year. Some equity holdings also detracted from returns, including

Process Pillar: Positive | Patricia Oey 12/07/2018 The managers take a contrarian approach, aiming to avoid hot parts of the market and buying what's out of favor. They are also patient in waiting for the market to recognize the value of the fund's holdings. The team's disciplined and risk-conscious approach earns it a Positive Process rating.

This allocation fund can invest as much as 30% of its assets in dividend-paying stocks. Beyond a dividend, the managers look for companies with improving balance sheets, good cash flow prospects, and some kind of competitive advantage that are trading relatively cheaply, often because of short-term issues.

The bulk of the portfolio is comprises corporate bonds, preferred stocks, and convertible securities. Within corporates, the team has focused on BBB-rated and high-yield securities but usually avoids the lowest-rated debt. The team invests across the capital structure so the fund will occasionally own both the equity and debt of a single company, limited to 3% of the portfolio.

The fund may also invest in other fixed-income instruments, such as Treasuries (it had nearly a 20% stake in them in 2008), but will avoid them completely when they look unattractive. The team takes a bottom-up approach in constructing the portfolio, but it will also let cash build when ideas are in short supply. The fund's cash stake rose as high as 33% in late 2014.

The fund's bond portfolio tends to change more significantly than its equity sleeve. For instance, the fund had a 20% Treasury stake in 2008. Now, the managers believe such bonds carry too much interest-rate risk and too little reward, so the focus is on corporates and, to a lesser extent, convertibles and preferred stock.

At the end of September 2018, 69% of assets was invested in corporates. Another 11% of assets was in convertibles, and 4% in preferreds. Since George Cipolloni took over in 2006, the portfolio's equity weighting has usually been 20%-30% of assets. It has been as high as 32% in August 2004, and it is currently at a historical low of 15%. Cash or short-term investments were 1% of assets.

The managers are also becoming more cautious in the corporate-bond portfolio. During the past three years, short-term securities increased from 30% to more than 70% of the corporate-bond sleeve. This reflects the managers' concern about the portfolio's exposure to the risk of rising rates. They used to keep duration within one year of the FTSE U.S. Broad Investment-Grade Bond Index, but as of September, the fund's duration was just 2.7 years versus the FTSE Index's 6.0 years. The team has also focused more on investment-grade bonds rather than high-yield issues. High-yield bonds currently account for 28% of the portfolio, down from a 42% average over Cipolloni's tenure.

Performance Pillar: Positive | Patricia Oey 12/07/2018 Since George Cipolloni became a manager in May 2006, its 6.2% annualized return through November 2018 handily beat the allocation--15% to 30% category average's 3.5% gain. Also, its risk-adjusted return over the trailing decade was in the category's top decile. Thus, the fund earns a Positive Performance rating.

Strong showings in 2008 and 2009 were key contributors to Cipolloni's record. In 2008, a slightly lower equity allocation and good stock selection resulted in a decline of 10.2%, far better than the category’s average decline of 16.2%. In 2009, the managers scooped up beaten-down high-yield and investment-grade debt, as well as convertible bonds. These purchases, along with strong stock selection, resulted in a 30.2% return that year versus the category's 19.3%.

The recent growth-led rally has been a headwind for this value-focused fund, and investors should expect the fund to lag when expensive assets continue to rally. 2017 was a particularly dismal year when its increasingly conservative portfolio, further hampered by a few large decliners in the equity sleeve, returned 3.9%, placing it in the category’s bottom decile.

But this fund has exhibited good downside protection, another key driver of long-term outperformance. When market volatility has spiked, such as in the summer of 2015, and more recently in February and October of 2018, this fund outperformed its average peer.

People Pillar: Positive | Patricia Oey 12/07/2018 Chartwell Investment Partners bought this fund's advisor, The Killen Group, in April 2016. The sale addressed succession issues and lead managers George Cipolloni and Mark Saylor are effectively locked in through December 2020. This fund's flexible process essentially resides with Cipolloni and Saylor, so there is key-person risk. In addition, with one dedicated analyst, this fund's three-person team is small given their global, all-asset investment universe. That said, Cipolloni's 16-year tenure on the fund and strong results under his leadership support a Positive People rating.

The two managers have worked together for more than a decade. Cipolloni joined Killen as an analyst for this fund in 2002, rising to a named manager in 2006. Mark Saylor joined as an analyst in 2007 and was promoted to portfolio manager in January 2014. Current analyst Peter Toscani also joined the team that month. From 2006 through February 2017, Lee Grout and Robert Killen were also listed as managers, but they were primarily responsible for a micro-cap equity fund and mid-cap value fund Berwyn Cornerstone BERCX, respectively. The three-person team has worked together for five years and believes it is sufficiently staffed.

The managers here invest alongside fundholders. Cipolloni owns more than $500,000 in fund shares and Saylor invests more than $100,000 in the fund, according to recent filings.

Parent Pillar: Neutral | 12/13/2017 Founded in 1997, Chartwell Investment Partners has focused on institutional relationships. The firm has been a subsidiary of TriState Capital TSC since May 2014. Moving further into the retail space, in April 2016 it bought The Killen Group, which manages the two Berwyn funds. Including Killen, Chartwell has five investment teams and manages roughly $8 billion in assets. With TriState's backing, the firm plans to make more acquisitions, but it is intent on acquiring only teams that are a good cultural fit.

Chartwell boasts positive traits. Co-founder and CEO Tim Riddle encourages collaboration among the teams and has been thoughtful about investment-team compensation. While comp could be longer-term oriented, it is based on performance and has contributed to solid manager retention rates. The firm has been appropriately focused on capacity management, having closed strategies in institutional channels, protecting the integrity of its smaller-cap mandates.

There is room for improvement. Some of the investment teams appear thinly resourced--Berwyn BERWX, a micro-cap fund, is run by one manager with no dedicated support, which is uncommon among stronger outfits. After performance struggles, the firm's growth-equity team was restructured in late 2016, and Vanguard simultaneously removed the firm as a subadvisor on Vanguard Explorer VEXPX. Chartwell receives a Neutral Parent rating.

Price Pillar: Positive | Patricia Oey 12/07/2018 This fund's below-average fees earn it a Positive Price rating.

The expense ratio for this fund's sole share class is 0.66%, which is below the conservative-allocation no-load average of 0.75%.

Parent Chartwell has a waiver so that fundholders' total costs, excluding acquired fund fees, do not exceed 0.64%. Last year's acquired fund fees were 0.02%.