Boost Your Equity Yield Without Reaching for It

A version of this article first appeared in the June 2019 issue of Morningstar FundInvestor.

In equity-income investing, you get what you don't reach for.

Stocks remain an important part of income-seeking investors' portfolios. A retiree's portfolio, for example, still could use some appreciation to avoid the risk of ruin, or the possibility of running out of money in retirement. Dividend-paying equities can supply that, as well as bolster an income stream.

Watch your step, though. There are many equity-income strategies that engage in all sorts of dubious tactics to attract income-fixated investors through boosting their headline yields. Some traffic in distressed companies, others in preferred stock or derivatives, and still others engage in "dividend capture" stratagems, which entail buying shares just before they pay their dividends and then quickly selling them. Such approaches can produce enticing, well-above-average yields, but they also increase risks, transaction costs, and tax impacts, while sacrificing total return.

There are, however, some no-artifice methods of providing consistent above-average yields. They include leavening the portfolio with some higher-yielding non-U.S. securities, looking further down the market-cap ladder, and controlling fees. Here are some examples.

American Funds Capital World Growth and Income CWGIX, which has a Morningstar Analyst Rating of Gold, doesn't have to stretch for yield because it has a big opportunity set and a reasonable goal. The fund can invest anywhere globally, but it must keep its yield close to the MSCI All-County World Index's. That keeps it diversified and out of trouble. The average dividend yield of its roughly 300 holdings is higher than that of iShares MSCI ACWI ETF ACWI, and the profitability metrics of its typical stock are at least in line with those of the passive option. It has some industry leanings, such as utilities, but its multiple, independent managers have been able to check volatility.

AllianzGI NFJ Small-Cap Value PCVAX reminds investors that there are dividend equity-income sources other than large, global multinationals. As of May 2019, this Bronze-rated fund offered a well-above-average trailing-12-month yield. It did so by adhering to subadvisor NFJ's proven process of investing only in dividend-paying stocks with valuations below those of industry peers. The portfolio of more than 100 stocks has an average dividend yield of 3% and better net margins, returns on assets, and returns on equity than the Russell 2000 Value Index. The fund has struggled to keep up in the long bull market, but it still can be a diversifying source of yield.

A foolproof way to boost your equity yield is to not pay a lot for it. Vanguard offers two excellent vehicles that do that--one active and one passive. Wellington Management's Michael Reckmeyer doesn't have to stretch far for higher-yielding stocks because Silver-rated Vanguard Equity Income VEIPX gives him a significant head start with one of the lowest expense ratios among actively managed large-value Morningstar Category funds. That allows Reckmeyer to all but shun the highest-yielding quartile of stocks where a lot of value traps lurk and focus on companies with more-solid fundamentals in the second-highest fourth. Vanguard's Quantitative Equity Group manages a slice of this portfolio, but Reckmeyer's deft stock-picking has made the difference here, helping the fund edge the firm's other great equity-income option: Vanguard High Dividend Yield Index VHYAX. This passive fund tracks the FTSE High Dividend Yield Index and has been hard for more-yield-focused dividend funds to beat, in large part because of its rock-bottom expense ratio.