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A Solid Equity-Income Fund Is Closing

Silver-rated American Century Equity Income gets ahead by losing less.

Securities In This Article
Chevron Corp
American Century Focused Lg Cap Val Inv
American Century Mid Cap Value Inv
American Century Equity Income Inv
Genuine Parts Co

The following is our latest Fund Analyst Report for American Century Equity Income Fund TWEIX. 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.

American Century Equity Income stays true to its prudent philosophy. The fund focuses on downside protection and capital preservation, which causes it to lag rivals when markets rally but stand out during periods of market unrest, as seen in early 2016. Even such brief periods of solid downside protection more than compensate for longer periods of trailing in up markets. This discipline has rewarded investors over time, earning the fund a Morningstar Analyst Rating of Silver.

Veteran value manager Phil Davidson and his team generate steady returns from a few sources. First, they supplement dividend-paying stocks with convertible bonds and preferred stocks. These are higher up the capital structure than equity and notably reduce the fund's volatility. Second, the team's stock selection emphasizes solid fundamentals, especially high returns on capital and stable revenues. Such long-term holdings as

The team is patient but adjusts the portfolio when opportunities present themselves. That's what happened in the 12 months through June 2016, when volatility enabled it to purchase stakes and increase weightings in a handful of trusted companies at attractive prices. For example, the fund first bought

The fund's peer-leading success has renewed investors' interest. Steady flows through 2016 increased fund assets to about $11 billion, and the fund will again close to new investors as of Oct. 24, 2016.

Process Pillar: Positive | Gretchen Rupp 09/16/2016 The fund's straightforward approach requires patience and discipline, and the team's unwavering consistency in carrying it out earns a Positive Process rating.

The team starts by trimming a universe of 6,000 stocks to approximately 500 firms that meet criteria on such quality factors as good returns on capital, low leverage, desirable franchise characteristics, and strong barriers to entry. This smaller group of stocks works as a long-term selection pool. Next, the team estimates a risk/reward ratio to rank potential picks. Finally, the team picks from dividend-paying stocks that are within the least-expensive half of the 500 potential holdings based on at least two of five valuation measures, including price/earnings, price/free cash flow, and dividend yield. Rather than spend time identifying new ideas, the team focuses efforts on ensuring that within the fund's current holdings, value propositions and quality characteristics remain stable. The fund's steady income mandate often leads to relatively large stakes in dividend-rich utilities and smaller weightings in information technology. Trading and sector rebalancing are key factors in risk management. The team trims winners and incorporates new opportunities with a higher chance of reversion, contributing to above-average turnover before 2013. Turnover has come down, and 2015's rate of 56% was about equal to the large-value Morningstar Category average.

Market volatility in late 2015 and early 2016 percolated attractive buying opportunities, and lead manager Phil Davidson and his team took advantage. As of June 2016, about 20% of assets had been acquired in within 12 months. The managers added a position in automotive parts distributor

The portfolio held about 22% of fund assets in convertible bonds, convertible preferred bonds, and preferred stocks as of June 2016. The historical range has been 15%-25% of assets, and most tend to be more equity-sensitive.

Performance Pillar: Positive | Gretchen Rupp 09/16/2016 This fund gets ahead by losing less, a perennial trait that was on display in 2016's first quarter when market volatility briefly spiked. The fund's 6.0% gain that quarter topped its Russell 3000 Value Index benchmark by about 440 basis points. Since lead manager Phil Davidson joined the fund in 1994 through August 2016, the fund tops its bogy by 100 basis points annually. The fund's downside resilience drives its strong long-term record. The unique combination of dividend-yielding stocks, convertible bonds, and preferred stock has helped to buffer losses in down periods better than most all-equity large-value portfolios. In fact, the fund captured only about 57% of the index's losses in down months during Davidson's tenure. And it's delivered an average 12-month yield of 2.6% in the past 10 years, better than about three fourths of large-value peers with an income objective.

The fund has been less volatile than most, with a 15-year standard deviation lower than 99% of all large-value funds. However, this lower-volatility strategy also can lead to lagging performance during extended rallies. In fact, during rolling three-year periods across Davidson's tenure through August 2016, the fund trails its benchmark 55% of the time. But patient investors who stick with the fund have been rewarded by healthy capital preservation in down periods; the fund earns a Positive Performance rating.

People Pillar: Positive | Gretchen Rupp 09/16/2016 This fund has been capably guided for more than 20 years by industry veteran Phil Davidson and earns a Positive People rating. Davidson also serves as the chief investment officer for the U.S. value equity group at American Century. Michael Liss and Kevin Toney join Davidson as portfolio managers; each has been with American Century for more than 15 years. Rounding out the capable team are managers Brian Woglom and Dan Gruemmer, as well as nine additional analysts.

The group has a clear approach across all its funds, emphasizing quality and value. The team members also manage

Davidson and Toney have between $100,001 and $500,000 invested in the fund; Liss invests a similar amount within the reduced-fee CIT version of the strategy.

Parent Pillar: Neutral | 06/24/2015 American Century has improved its stewardship traits in some areas. Although the firm has seen a few recent portfolio manager departures in 2015 and one senior manager departure in 2014, manager turnover is not the problem it was several years ago. Moreover, its level of manager investment, which signals conviction in a manager's strategy and creates financial alignment with fundholders, has increased significantly over the past several years. CEO Jonathan Thomas has been in place since 2007 and has led with a steady hand, focusing on institutional markets.

American Century has more to prove. The firm's co-CIO structure is still fairly new--just around 18 months as of mid-2015. Co-CIOs David MacEwen, an American Century veteran who remains a named portfolio manager on several fixed-income funds, and co-CIO Victor Zhang, who joined the firm from Wilshire in early 2014, share responsibility for the performance of all of American Century's funds. One early order of business was a change to the fund managers' bonus plans, which now place greater emphasis on longer-term performance and peer rankings. Meanwhile, the firm is expanding its liquid-alternatives effort with a mid- to late-2015 launch of three new alternatives funds, which will be run by a third party. Whether these changes will be positives for fundholders remains to be seen.

Price Pillar: Neutral | Gretchen Rupp 09/16/2016 The Investor shares of this fund, which hold the bulk of its assets, have an expense ratio of 0.94%. This lands in the Average range for the group of no-load large-cap domestic-stock funds. The A shares and the Institutional shares are the only other classes with meaningful assets, and they fall in the Average and the Below Average range for their respective share classes. On an asset-weighted basis, the Morningstar Fee Level ranking across similarly distributed fund groups is Average, resulting in a Neutral Price rating.

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About the Author

Gretchen Rupp


Gretchen Rupp is a manager research analyst for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. She covers multiasset strategies, focusing on allocation funds and 529 college-savings plans.

Before joining Morningstar in 2014, Rupp was a defined-benefit pension plan consultant for Towers Watson (formerly Towers Perrin). She also has experience in strategy consulting and investment banking.

Rupp holds a bachelor’s degree in math and statistics from Miami University and a master’s degree in business administration from The Wharton School of the University of Pennsylvania.

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