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Equity Income: Performance and Wealth Preservation
“A manager who limited losses last year went a huge way toward helping investors accumulate wealth over time and meet their long-term goals,” Morningstar’s Don Phillips told the Wall Street Journal in early November for an article titled, “The Cruel Math of Big Losses.” “It’s the kind of victory that often goes unnoticed,” Phillips said.
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such a victory last year. Here was the calculus: Equity Income declined -20.05% during a tumultuous 2008, versus a -37.00% decline for the S&P 500 Index. That meant American Century Investments’ most conservative value-oriented portfolio captured only 55% of the downside of one of the steepest bear markets in history. That performance in 2008 relative to both the broad market and peers hardly went unnoticed by financial professionals who recommended the portfolio to their clients, or Morningstar, which ranked the fund highly.
Retired Investors Have Two Goals
That type of performance—known as liability-driven investing—resonates with risk-averse equity investors, none more so than retirees or soon-to-be-retired investors in the final stages of accumulating wealth. No group needs more from an investment:
Wealth Preservation
Preserving wealth dramatically increases in importance for retired investors. Apprehensive about wide swings in the stock market, retirees place great value on the predictability of their returns.
Performance
As the demographics make clear, retirees also need to grow their money over time to help provide for a potentially long lifetime. Research by Benefits and Pension Monitor magazine shows that women currently aged 65 have more than an 80% probability of reaching age 80; men have about a 65% chance. That certainly calls for assessing financial needs in retirement on a household basis, not an individual one. Couples where both spouses are 65 have a 50% chance of both reaching age 80.
The baby-boom generation is nearly 79-million strong. In 10 years, more than a third of them will be over 65. And they will need money to spend. According to the Center for Media Research:
• 13% of new automobile purchasers are retired.
• 16% of adults who frequently stay in hotels are retired.
• Retirees make up 20% of adults who frequently dine out.
• 14% of those planning to take an ocean cruise in the next year are retired.
With all that in mind, as financial professionals well know, the marching order for a retiree’s investment becomes: “Position me to capture opportunities for capital appreciation, but protect my savings against potentially steep market declines.”
A History of Winning by Not Losing
2008 was not a random event for Equity Income. The portfolio has a history of providing upside equity-market participation along with downside protection. Since its inception in the fall of 1994 through September 30, 2009, Equity Income has captured 69% of the S&P 500’s upside performance, but only 55% of its downside.
A Consistent Risk Profile
While the Equity Income portfolio can’t guarantee first-percentile levels of performance in every market downturn, co-portfolio managers Phil Davidson, Kevin Toney, and Michael Liss have been consistently successful in dampening volatility for investors. The key to their portfolio’s performance in down markets has been its emphasis on stronger, financially sound businesses whose securities provide attractive yields, and convertible securities. (Convertibles—normally convertible bonds or convertible preferred stock—can be converted into a different security at the holder’s request, typically shares of common stock.)
Strong Balance Sheets and Dividend Yield Help Control Risk
As they seek high-quality companies selling at a discount, Davidson, Toney, and Liss place great weight on strong balance sheets, believing that businesses with solid financials are better positioned to weather challenging periods and continue to reward shareholders.
Another important sign of financial strength is the regular dividend payments that are the portfolio’s top priority. In the investment team’s view, dividend-paying companies tend to harbor less risk. They’re more likely to be seasoned companies with stronger earnings and cash flows.
Consistency of Returns
To provide a closer look at Equity Income’s track record of generating positive returns over time, we looked at the portfolio’s success rate in achieving an 8% rate of return. The table below indicates that during the past 10 years, the portfolio has produced an absolute return above the 8% mark in 82% of rolling five-year periods—more than double the 37% figure for the S&P 500.
What about the other 18% of the time? For that portion of the rolling five-year periods where Equity Income’s return was less than 8%, the average annualized excess return versus the S&P 500 was 4.51%. In fact, Equity Income either had a return above 8%, or beat the S&P 500 in all 121 rolling five-year periods on a monthly basis.
An Illustration of Downside Protection
Measuring Equity Income’s two bear-market performances and peak-to-trough declines since its inception, we see that the portfolio has delivered fewer, shorter, and less-severe drawdowns than the broad market and its benchmark, the Russell 3000 Value Index. Examining the chart, we note that over the 123 months since September 30, 1999, Equity Income leads the S&P 500 Index and the Russell 3000 Value Index in terms of the number of months of positive performance. The portfolio has eight fewer down months than the S&P 500. During those up months, Equity Income has provided a very respectable average return of 2.36%, roughly 70 basis points behind the broad-market index. On the down side, the portfolio’s average decline of -2.79% is 133 basis points ahead of the average for the S&P 500. (For this average-return comparison, the up and down months for the portfolio and index are strung together as if they occurred consecutively.)
The performance rubber meets the road in the “Max Drawdown” column, which represents the portfolio’s and index’s steepest declines. Thanks to its ability to protect gains achieved in positive markets, Equity Income has a much smaller climb to make following the stock market’s historic decline.
Not Just for Senior Citizens
While tailor-made for many retirees’ investment goals, Equity Income also can be an ideal investment for people at other stages of their investing life. With a goal of providing consistent, risk-adjusted returns, the portfolio can be a great core investment for long-term equity investors who want to take a conservative approach to the stock market. Equity Income can also act as an effective diversifier for more aggressive equity portfolios.
November 2009
Past performance is no guarantee of future results. Investment return and principal value will fluctuate and it is possible to lose money by investing.
Before investing, carefully consider the fund’s investment objectives, risks, charges and
expenses. Contact 1-800-345-6488 for a prospectus containing this and other information. Read it carefully.
The opinions expressed are those of the investment managers and are no guarantee of the future performance of any American Century portfolio. Statements represent personal views and compensation has not been received in connection with such views. This information is not intended to serve as investment advice.
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Kansas City, MO 64141-6385
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American Century Investment Services, Inc., Distributor
©2009 American Century Proprietary Holdings Inc. All rights reserved.
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