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K4 Fund Selection lets you quickly and easily build weighted factor models to evaluate and monitor mutual funds and ETFs. Listed below are the scoring factors, filters, and weights for this model. This illustration is for Domestic Equity, but it can easily be adapted for other equity categories.
Basis for Model Design
Ever since the mid-1920s, dividend yield has
accounted for about two-thirds of the S&P 500’s real return.
Although we often think of capital appreciation as the
driving force behind equity returns, once inflation is stripped away,
it has only contributed half as much as dividends.
With the S&P 500 currently yielding a mere 1.7%, dividends
are often overlooked in fund selection. There are, however, funds that have consistently boasted
above-average yield and superior total return.
Equity-Income Funds are typically preferred by
more conservative investors who don’t mind sacrificing a little
upside potential for the yield’s downside cushion.
Their appeal grew in 2003 when Congress passed legislation
granting favorable tax treatment to stock dividends.
With economic growth now decelerating, even more investors
may see their appeal.
Although Morningstar has no “Equity-Income” category,
Klein Decisions’ K4 Fund Selection can still help you evaluate Equity-Income Funds.
This model rewards funds with strong dividends by requiring a
minimum yield of 3.5%, roughly twice that of the S&P 500.
To maximize net yield, expense ratios should be minimized and
12b-1 fees avoided. Total Return NAV and the Sharpe Ratio serve as measures of
total return and risk-adjusted return.
The number of negative months over the past three years gives
a perspective on downside protection. Since many Equity-Income Funds were launched after the 2003
tax act, the minimum track record is limited to three years. Finally, because this is an analysis of stock funds, funds with any fixed income or convertible securities are excluded.
| Categories |
Selections |
| Product Type |
Fund |
| Asset Type |
Stock |
| Track Record |
3 Years |
| Domestic Equity |
Large Cap, Mid Cap, Small Cap |
| Criteria |
K4 Factor |
Weight |
| Maximize Yield |
Expense Ratio |
Medium-Low |
| Total Return |
3-Year Return NAV |
High |
| Downside Protection |
3-Year Negative Months |
Lowest |
| Risk-Adjusted Return |
3-Year Sharpe Ratio |
Medium |
| Yield |
Trailing 12-mo Distribution Yield |
Highest |
| Filter |
Limits |
| Percent in Bonds |
Maximum Value =0 |
| Percent in Convertibles |
Maximum Value = 0 |
| Trailing 12-mo Distribution Yield |
Minimum Value = 3.5% |
| Actual 12b-1 Fee |
Maximum Value = 0 |
Results
The highest ranked
funds are those with above-average yield and risk-adjusted returns
over the past three years. Notice that “12-Month Dist. Yield” is used
both as a preference item and then again as a filter.
It is used as a scoring factor to reward funds with greater yields while
as a filter it sets the minimum yield to be considered, in this case
3.5%.
Although this scenario covers all domestic
equity capitalizations, it might intuitively seem that all
top-performing Equity Income Funds would come from Large Cap Value.
That, however, wasn’t the case when this model was run using
June 30, 2007 data. At that point, nine funds survived the rigorous filters, with only
three coming from Large Cap Value. Of the remainder, two were in Large Cap Blend, one in Mid Cap
Value, two in Small Cap Value, and one in Small Cap Blend.
Dividend stocks and the funds that buy them can obviously be
found in all capitalizations.
When it’s time to review the funds, K4 Fund Selection users can simply copy
and rename each scenario with the current date. When you open a
copy, you can proceed directly to the results page and view the
updated data. The update is automatic with no data downloads or information to set up. You can then
compare the current results to those in the original scenario. This
is also a simple means of creating an ongoing archive of your
analyses to track the funds over time.
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