January 11, 2023
In this wide-ranging discussion, the portfolio managers of Vanguard Dividend Growth Fund explain why dividends and valuations are merely the “portals” of their investment approach, and what the lessons of the recent past portend for the future.
Meet the experts
Donald J. Kilbride
Peter C. Fisher
Donald J. Kilbride and Peter C. Fisher of Wellington Management Company LLP are the portfolio managers for Vanguard Dividend Growth Fund, which has roughly $55 billion in assets under management as of November 30, 2022. Kilbride is also the manager for Vanguard Advice Select Dividend Growth Fund, which is currently only available through Vanguard Personal Advisor Services. Fisher also manages non-Vanguard institutional separately managed accounts with a similar mandate as Dividend Growth Fund but focusing on international and global equities.
Notes: This interview was edited for length and clarity. It took place November 29, 2022, so some of the details, figures, and comments are pertinent to that time frame.
Kilbride: Thursday is my 20th anniversary of joining Wellington, so I’ve been there a long time. I started at the Wellington Fund working with Ed Bousa (who previously managed the equity portion of that fund). I took over Dividend Growth in 2006 and have been the PM on that ever since.
Fisher: I worked for MFS in Boston as an industry analyst before I came to Wellington in 2005. Then I went to business school at the University of Chicago and started working with Don around 2012. One of the things that Don did for me when I joined was let me have access to the whole portfolio. So I began as an analyst on the team, but really a generalist working with him on the whole portfolio. Then in 2016, I moved to London and took over the global version of Dividend Growth and then in 2019 started International Dividend Growth. I continued to work with Don on the U.S. fund while I did those things. I came back here in 2019 just in time for COVID.
We found my being in London to be valuable. When I first went, our thinking was that it would be mostly valuable for the global or international portfolio. But what we realized was—because the companies we were investing in are so global and multinational—we really needed to understand the non-U.S. portions of those businesses better than we did. Our investment team has expanded to four people, one of whom is now in London, focusing on non-U.S. stocks and the non-U.S. portions of U.S. businesses.
Kilbride: I have long held the view that the amount of fiscal and monetary stimulus we've experienced post-global financial crisis—so for the last 13 years or so—have been excessive. It was necessary; I think most would agree that they had to be aggressive to keep us from tipping over into high unemployment. The Fed buying every asset out there had the effect of reducing risk, which encouraged people to invest, which had a daisy chain effect of companies doing better and feeling more confident in hiring. The stimulus was medicine that worked, but we have too much of it in our system.
For 10-plus years we've had rates that were low to artificially low, mispricing risk when risks around us were going up. I think we could all agree that the world is more risky now. So there was a disconnect, and you can see how it got out of whack. This was all going to eventually lead to inflation showing up again. It just took a lot longer than any of us thought. The pandemic, the war, and other things helped to hasten it.
So where are we today? The Fed chairman has told us pretty clearly that he's channeling [former Fed Chairman Paul] Volcker, that he is going to attack inflation first and foremost and he's not going to worry about the aftereffect. That to me makes it really hard to see how this all lands softly. So that's a long-winded way of saying I'm still cautious personally. I think the odds are better that we end up in a recession of some sort than not, which means the portfolio’s positioning should be relatively more defensive, which is what we've been doing for a few years now and I think we're finally at the point where we're in good shape. I think our companies will generally do better than most in a recessionary environment. And I'm confident that by and large most of our companies can handle inflation well.
Fisher: Our philosophy and process are simple. We're trying to find companies that can compound their values sustainably over time. We want the bulk of the return for the shareholder to be driven by the growth of the businesses and the dividends they pay, as opposed to us quickly trading in and out of stocks, which means a lower turnover strategy.
We're looking for companies that, on the one hand, invest in their business for growth, but have the capital discipline to give the excess back to us in the form of a growing dividend.
Kilbride: The dividend is important, but it's just a portal to finding companies that are high quality, the effective compounders generating growth that exceeds inflation over time.
Fisher: We also focus on the downside resilience of businesses. We're always thinking about how the compounding machine can be disrupted in some way. The last piece is just being very, very patient. Both when we buy companies and when we sell them. We tend to own things a long time.
Fisher: For us, valuation is the last piece of the puzzle. We don't want valuation to be the key in driving our activity. When we bought things just because we thought they were cheap, typically they didn't work out very well. Good things typically have a premium attached to them and we're happy to pay the premium. So valuation as a measure is never the first thing that we're after, but if a business does have the characteristics we want, it's a compounder. We wait for opportunities when it's on sale to add to the position. When a group of stocks does really well over a period of years, we're typically going to be trimming that and recycling that money into things that have done poorly.
Fisher: The key thing to know is that Mastercard and Visa provide the network. They don't actually issue the card; they don't take the credit risk. They're simply providing the rails, the connections between the banks who are issuing the cards and the merchants who accept them on the other side. They have so many people who have signed up over the last 60 years, so many customers who have their cards, so many retailers who accept their card, so many banks who issue their cards that they have this network that's hard to supplant.
They have returns on capital and margins which are incredibly high. They grow as the overall economy grows and as people shift their consumption away from using cash to using credit cards. So there's just an underlying growth driver with enormous profitability for these businesses.
In the last couple of years, there's been more noise around new entrants in the payments area, creating concern in the marketplace that Visa and Mastercard are going to be disrupted. We’ve lived through these cycles before. Competitors have come in over time—PayPal, Apple Pay—with the idea that they were going to supplant the Visa/Mastercard network system.
But then they realize they're never going to be able to do it, that they’re better off just using the existing Visa/Mastercard infrastructure. So they end up basically being another customer for Visa/Mastercard. We've seen this cycle over and over again.
When these stocks were weak last year around these concerns about payment competition, we took that as an opportunity to add to Visa, which we already owned, then started a position in Mastercard for the same reason.
Fisher: Consumer staples are an example of where we've seen price increases of 7, 8, 9, 10 percent and those price increases haven't really affected consumers’ buying habits dramatically. People need to brush their teeth, right? They have to buy toothpaste. So they're going to be pretty insensitive to the price of the toothpaste, to a limit. And so far we've seen that play out.
We have other companies in the portfolio, Visa and Mastercard among them, where their revenue goes up as prices go up. So they have a built-in price hedge, insulating them from any negative impacts of inflation. The portfolio overall is well positioned.
For some companies there may be a limit to pricing. At some point, people might be less inclined to brush their teeth. We'll have to watch out for that.
Fisher: We have always felt like you would never want to own a company that cut their dividend. For us the dividend is about prudence. For most companies, if you cut your dividend it means you've been imprudent somewhere along the way. With COVID, we had to think differently about that. TJX cut their dividend because their stores shut down. That was the only rational, prudent thing to do, to cut your dividend because we're living in a world where you don’t know what was going to happen. We had to think differently about what a dividend means and what does it mean to cut it.
Kilbride: Our philosophy won’t change, but the process will. Philosophy is what you believe in. It’s our North Star that rarely changes. It has to be consistent, or you’ll get lost, especially in periods of volatility. Processes are how you execute on that belief, and the tools that you use. Those things change and should change.
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