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Investors
who want stable returns, low
price volatility and fund
managers staying on top of
the yield curve will like
what these three fund managers
have to say. They are disciplined
in their investment approach,
seeking stable returns. Nancy
Crouse focuses on large cap
value stocks generating dividend
income, Damon Andres looks
after REITs and convertible
securities, and Tim Rabe generates
returns following the high-yield
sector of the market.
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Q:
Nancy,
will you explain the fund’s
origin and the mission?
A:
The Dividend Income Fund was
started with the internal
resources of Delaware in 1996.
Since October 2003, the fund
has been open to the public.
The investment strategy of
the fund is to provide a stable
income stream and competitive
total return to investors
over a variety of market cycles.
The fully invested fund does
not time the markets in four
sectors that we invest in.
The fund has four categories
of assets: 40% of the fund
is in large cap value equity
securities, 25% in high yield
bonds, 20% in REITs, and 15%
in convertible securities.
We arrived at this allocation
based on the analysis of the
historical data on asset classes
and an understanding of the
volatility of each. Each of
the sleeves in the fund has
relatively low correlation
with other asset classes in
the fund. This feature offsets
dramatic market swings and
helps the fund ride out the
volatile market cycles. Since
the inception, the fund has
not had a down year when measured
on total return basis. The
fund’s stable returns
are explained by the diversification
across four asset classes.
The four sleeves in the fund
are managed by three senior
managers. I am responsible
for the large cap value sleeve
in the fund.
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Q:
How
do you manage the Large Cap
Value sector for this fund?
What are your investment criteria?
A:
We manage all the sectors
in the fund using our extensive
research capabilities. At
Delaware, we have thirteen
equity analysts in the large
cap value area organized by
economic sectors. We use their
work to determine the optimal
holdings for the fund. We
are looking for large cap
companies that have the wherewithal
to generate excess cash flow
to pay dividends to investors
or to repurchase stock. We
are focused on companies that
are shareholder-focused and
are attractively valued when
measured on cash flow, EBITDA
and price-to-earnings ratio.
In general, we have between
25 and 40 stocks. As of this
interview, we had 33 stocks,
diversified across sectors.
The equity performance is
measured against Russell 1000
Value Index. We use financial
models to evaluate each company’s
ability to generate cash and
project future growth. Our
stock selection process is
one stock at a time.
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Q:
Can
you describe your research
process?
A:
Our goal is to identify stocks
of companies that have predictable
and consistent cash flow.
During our selection process
we do not use any forecasts
in favor or against the economic
outlook that aren’t
confirmed by the underlying
fundamentals of the companies
being considered. We are looking
to buy companies that have
a dividend yield above the
market yield or repurchase
a meaningful amount of their
shares. We identify these
companies through our fundamental
and quantitative analysis.
We gather our information
through management meetings,
competitive analysis, company
visits, and industry shows.
We use financial models to
understand the cash flow and
impact on the cash flows in
various economic and market
cycles. We are looking for
companies that have stable
cash flow during various cycles.
In meeting with management,
we try to understand the macro
business outlook and temperament
of the management. The outcome
of the meetings and financial
modeling is our estimation
of fair value for the stock,
and this is our method of
the stock selection.
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Q:
Will you discuss some of your
recent stock picks? Why did
you choose these stocks?
A:
Last fall, we brought Kerr
McGee into the portfolio.
At the time the company had
the attractive dividend yield
of 4.5%. We have been following
the company for several years
at Delaware, and we have a
good knowledge of its energy
asset base in the Gulf Basin
area. We had a different view
on the company’s stock
price since we understood
its Exploration and Production
capabilities. The company
had increased their exploration
success rate, and the dividend
looked safe. We viewed the
catalyst for the stock as
the better recognition by
investors of the value of
its asset base and better
management of the properties
and the potential spin off
of the paint-related chemical
business. Our extensive research
helped us to have a different
perspective on the company,
which led us to reap investment
gains.
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Q:
Can
you share another success
story?
A:
Pepsico Inc. has been in the
fund for at least two years.
During 1999 and 2000, our
dividend-based investing approach
was not fashionable. We viewed
the company as a good corporate
citizen, and we liked the
fact that the company had
a 46% increase in the dividend
in one year. The company has
a steady cash flow to support
the growth in dividends. Pepsi
stock was out of favor when
the company had short-term
disruption in volume growth
at the Frito Lay division.
During that time, we added
the stock to the portfolio.
Since 2001, stocks with reasonable
dividend payouts have done
better than the market, and
we have been rewarded for
our disciplined investing
approach.
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Q:
How
do you measure and control
investment risk?
A:
We
monitor securities risk at
the sub-industry level across
the complete fund and pay
attention to sector allocation.
We keep the fund diversified
among sectors similar to S&P
500 and Russell 1000 indexes.
The high-yield
portion of the fund has more
than 100 bonds. They have
20 credit analysts, and a
deep research team. There
is higher level of turnover
than in the rest of the fund.
They take a sector-neutral
approach, and BB and lower
ratings are selected for the
fund.
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Q:
Damon,
what is your REIT investing
philosophy?
A:
We are a total return-focused
investor. We do not stretch
for the higher-yielding REITs
just to get income. Since
all REITs generate higher
dividends than the broad market,
we can focus on higher quality
companies and still get good
dividend yield.
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Q:
Can
you describe your research
approach?
A:
We
conduct research at three
levels: financial analysis,
property analysis, and qualitative
analysis.
During
the financial analysis, which
is focused on the balance
sheet and income statement,
we are looking for a strong
balance sheet that is not
heavily leveraged. We also
try to understand the quality
and recurrence of cash flows.
While conducting property-level
analysis we look at the property
portfolio. We differentiate
the eal estate quality from
the cash flow quality. Lower-quality
cash flow implies higher credit
risk, but lower real estate
quality does not imply higher
risk. We think that kind of
real estate is just a different
real estate class. In the
right market environment Class
B property can produce higher
returns than the Class A property.
So we try to focus on understanding
the real estate quality in
addition to the competitiveness
of the properties that our
companies hold. Our qualitative
analysis is focused on the
corporate structure and management
ability to formulate and execute
long-term plans that will
add shareholder value. Our
focus is also to diversify
across property types, such
as multi-family, hotels, office
and industrial properties,
and geographic regions.
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Q:
Can
you discuss how you pick a
REIT and share with us one
of your recent picks?
A:
We
are focused on finding companies
that meet our criteria on
the three research aspects
I just described. We focus
on the company, not the sector.
Duke
Realty is a company focused
on office and industrial properties
in the Midwest. The company
continued to outperform during
the late nineties even when
the California-focused REITs
were in demand. The Midwest
is a relatively slow growth
market. But even with that,
the company continued to deliver
strong revenue and earnings
growth and above-average R.O.E.
They have highly sought-after
real estate development expertise
and have a very competitive
portfolio of properties in
their markets. Even while
their markets have below-average
rental growth and high vacancy
levels, their assets significantly
outperformed the market. This
is because of management strength,
the competitiveness of their
portfolio, and their development
expertise.
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Q:
Are
you a long-term investor?
A:
We generally manage
with low turnover and invest
for the longer-term in quality
REITs. However, we are price-target
driven and not time-frame
driven.
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Q:
The
popular perception is that
rising interest rates will
hurt the REIT business.
What are your views on that?
A:
The basic demand for
REITs is coming from economic
health, job and wage increases
and population growth in specific
markets. In our view, we are
entering in a long period
of rising rates. When they
start to rise, the important
issue will be the magnitude
and the severity of the increases.
Currently rates are moving
very slowly, and that is positive
for REITs. Dividend growth
rate for the last seven years
has been about 7%. This offsets
the interest rates fear. Some
people fear that REITs have
a lot of variable debt, but
the reality is different.
Most REITs have little or
no variable debt. I believe
that the coming period of
rising interest rate will
also reflect higher level
of vitality in the economic
environment.
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Q:
Why
are convertible securities
in the fund?
A:
Convertible
securities form 15% of the
fund with approximately 25
securities. They are less
volatile relative to the bond
and equities and have the
upside participation of the
equities. The convertibles
allows us to have exposure
to other parts of the market
that we can not get through
REITs, high yield bonds, or
large cap value. It also allows
us to leverage the expertise
of the research that we have
in other sectors such as mid-
and large-cap equities. For
example, Constellation Brands
is a small cap company. We
have this company’s
convertible bonds, and we
believe that we will have
75% or more of the upside
when the company’s common
stock appreciates. The company
is one of the largest distributors
of imported alcoholic beverages
from Mexico and Australia.
The
fund is designed for the risk-adverse
investor who is looking to
round out the well-diversified
portfolio, who has high need
for income, and who demands
lower price volatility.
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Q:
Tim,
how is the High Yield sector
contributing to the fund?
A:
This portion of the
fund has 100 to 150 securities
in the portfolio that are
non-investment grade bonds,
that versus the Bear Stearns
High Yield index have slightly
higher credit risk so the
portfolio outyields the benchmark.
We base our investment process
on security selection to generate
alpha, therefore relying less
on macro level analysis to
effect performance. Our average
position is 0.75%, which gives
us ample diversification,
but a focused enough portfolio
to allow our bottom-up philosophy
to work. In the past, we have
underweighted healthcare because
of the fundamentals and underweighted
gaming because of the yield
in the sector. We have not
owned airline bonds, but inside
the transportation sector
we have been in shipping bonds
because it has more stable
cash flow than the airline
sector.
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