Amid Rising Rates, These Equity-Income Funds Offer a Lot to Like

These equity-income strategies tend to hold up better in market selloffs while providing a reasonable income stream.

Amid Rising Rates, These Equity-Income Funds Offer a Lot to Like

David Carey

Mar 14, 2022

Mentioned: Original Postqiax/quote">Principal Equity Income A (PQIAX), American Century Equity Income Inv (TWEIX), Apple Inc (AAPL), Taiwan Semiconductor Manufacturing Co Ltd (TSM), Neuberger Berman Equity Income A (NBHAX)

The article was published in the February 2022 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting the website.

Value came back in a big way in 2021. The large-value Morningstar Category returned 26.2% for the year, beating out its large-growth competitors for the first time since 2016. What’s more, the S&P 500 Quality High Dividend Index, which tracks the companies with the highest dividend yields, returned a healthy 28.9% in 2021.

The average large-value equity-income fund also enjoyed a solid 2021 but slightly lagged its large-value peers, returning 25.4%. Amid inflation concerns and expectations that the Federal Reserve will raise rates in 2022, investors are keeping a watchful eye on higher-yielding stocks, which are sensitive to interest-rate shifts. That said, certain equity-income funds can play a good supporting role in a portfolio given their tendency to hold up better in market selloffs while giving investors a reasonable income stream.

For investors seeking a fund with great downside protection, American Century Equity Income (TWEIX) fits the bill. Despite the fund’s bouts of underperformance during market rallies, it has proved its resiliency in down markets. The fund, which has a Morningstar Analyst Rating of Silver, held up well during the 2007-09 global financial crisis: It lost 38.3%, which was far better than the Russell 3000 Value Index’s 60.1% pummeling. It helps that the fund owns some convertibles, preferreds, and options, which boost income and temper risk. Given manager Phil Davidson’s conservative approach and the strategy’s income tilt damping returns during rising interest-rate environments, it should come as no surprise the fund underperformed in 2021. Its 16.8% return lagged the index’s 26.5% mark and landed it in the bottom decile among its category peers. Still, it receives a High Process rating because of its focus on income and stability in the companies it invests in. Through March 11, 2022, the fund’s 3.66% year-to-date loss puts it in the top half of its large-value category, beating the average peer’s 4.81% decline. Over the past 15-year period through February, its 7.6% returns topped the category’s 7.4%, suggesting that Davidson’s approach has long-term appeal.

A more-diverse equity-income option is Bronze-rated Principal Equity Income (PQIAX). The team here balances dividend yield and capital appreciation and looks for companies with dividend yields between 2.5% and 7.0% and payout ratios under 60%. Furthermore, it focuses on finding stocks with returns of at least 10% via capital appreciation and dividends. Still, the team does not stretch for yield, and the January portfolio's yield of 2.24% reflects that. The team looks for companies based on competitive advantage, financial strength, and profit prospects, among other factors, which should bode well during market downturns. It will typically cap individual holdings at 3% of assets and isn’t afraid to invest outside the benchmark, holding names such as Apple (AAPL) and Taiwan Semiconductor Manufacturing (TSM). The fund’s year-to-date 2022 performance through March 11, 2022, has been disappointing, however. Its 8.78% loss severely lags the large-value category average loss of 4.81%, landing the fund in the bottom decile of its peer group. However, historical performance suggests more optimism; the fund held up slightly better than the Russell 1000 Value Index during 2020’s first-quarter selloff and has a solid long-term track record.

Bronze-rated Neuberger Berman Equity Income (NBHAX) earns an Above Average Process rating for its four-bucket approach to mitigate risk. Included in these buckets are utilities and REIT sleeves, which represented 11% and 14% of the fund’s assets as of January 2022. Like American Century Equity Income, the portfolio ranges beyond equities and includes a convertible-bond sleeve for downside protection. The four experienced managers learned from their disappointing performance during the 2013 taper tantrum amid news the Fed would reduce its bond purchases, and they began monitoring the portfolio’s risk factors, which might help them navigate future rising-rate environments. Amid the expectation of more rate hikes in 2022, the fund has held its ground. For the year to date through March 11, 2022, the fund’s 1.45% loss ranks in the top quintile of its large-value peers. And the portfolio’s 2.8% dividend yield was well above the category average of 2.3% as of January 2022