Unlocking the Potential: A Deep Dive into Vanguard's High Yield Dividend Funds - VHDYX, VYM, and VDY

I had written a prior article on VDAIX (Vanguard Dividend Appreciation Index Fund). VDAIX is a superb fund for investors in search of top-tier dividend stocks, even if their primary concern isn't achieving the highest dividend yield. It's better described as a high-quality asset, prioritizing stability and growth over raw dividend payouts. In this article, we'll shift our focus to another exceptional fund, the Vanguard High Yield Dividend Index Fund, VHDYX.

VHDYX, the Vanguard High Yield Dividend Index Fund, is a meticulously designed index fund tailored to closely replicate the movements of the FTSE High Dividend Yield Index. The distinguishing feature of this fund is its unwavering focus on dividend payments as the sole criterion for stock selection, without delving into the aspect of dividend payment consistency. In other words, VHDYX assembles its portfolio by targeting stocks with a promising 12 Month Forward Dividend Yield, setting aside REITs from the equation. It's important to note that special distributions are not considered part of the dividend calculation for this fund. 

So, what's the key to becoming a part of VHDYX's holdings? It's a simple and transparent process – any company that is projected to offer an above-average dividend yield (excluding REITs) finds its place in the fund. VHDYX's selection methodology hinges on the 12 Month Forward Dividend Yield forecasts, and companies that rank above the 50th percentile in terms of their yield become constituents in the index. In essence, this fund places no additional criteria for stock selection, making it a straightforward and attractive choice for investors seeking high dividend yields without the complexities of additional metrics.

VHDYX, the Vanguard High Yield Dividend Index Fund, comprises an impressive portfolio of 401 carefully selected stocks and boasts assets under management (AUM) totaling $28.9 billion. As we delve deeper into this fund's holdings, let's uncover the top 12 positions within VHDYX.

VHDYX, while primarily driven by dividend yield considerations, presents a noteworthy aspect of sector diversification due to its market capitalization-based stock weighting. Among its top 10 holdings, collectively accounting for approximately 30.6% of its net assets, VHDYX maintains a balanced allocation across various sectors.

Notably, the two leading sectors within VHDYX are Technology at 15.44% and Finance at 14.05%. This diversification stands in contrast to the S&P 500, where the technology sector constitutes a higher proportion at 24.00%. VHDYX's strategic allocation ensures a more balanced exposure to different industries while still maintaining a core focus on dividend yield.

VHDYX falls within the "Large Value" category, reflecting its inclination toward value-oriented investments. The current composition of stocks in VHDYX exhibits a distinct tilt towards the value spectrum. This inclination is driven by the fact that large capitalization stocks, which dominate this fund, often offer more generous dividend payouts.

Remarkably, VHDYX maintains its commitment to high yields while skillfully diversifying across an array of sectors and capitalization levels. This unique balance enables the fund to harness the benefits of large capitalization stocks without sacrificing diversification.

Furthermore, it's worth noting that nearly 49% of the stocks within VHDYX possess wide economic moats, characterized by their insulation from competition through factors such as size, patents, or popularity. This factor adds a layer of stability and resilience to the fund's overall strategy, making it an appealing choice for investors seeking a blend of value, diversification, and strong competitive positioning.

It's a common misconception that high dividends inevitably translate into superior returns. VHDYX, the Vanguard High Yield Dividend Index Fund, has demonstrated the potential for outperforming the benchmark S&P 500 index, offering a compelling case for investors.

Examining its 10-year annual performance, VHDYX has consistently outpaced the S&P 500 index fund, VFINX. This remarkable achievement can be attributed to VHDYX's investment focus on value stocks. While value stocks may exhibit a tendency to underperform the broader market during bullish phases, they tend to provide a smoother and more resilient investment experience during bear markets.

In essence, VHDYX's ability to navigate both bull and bear markets, offering potentially superior returns while minimizing volatility, underscores its appeal as an option for investors seeking a balanced combination of value and stability.

VHDYX has exhibited remarkable price growth, particularly since 2008, aligning with the broader bullish market trends. Concurrently, its dividend payments have showcased a consistent upward trajectory since the latter half of 2010. It's important to note that periodic drops in dividend payouts are not unusual within VHDYX, given its selection criteria primarily focus on yield rather than the sustained ability to pay dividends.

Nonetheless, the overall trend in dividend per share remains encouraging, showing a consistent upward progression. The dividend yield has consistently hovered in the range of 2.5% to 3.0%, further underscoring the fund's reliability as a choice for investors seeking a combination of capital appreciation and a dependable income stream.

When it comes to mutual funds, VHDYX stands out as a distinguished choice, consistently earning top-notch ratings from reputable sources. US News, for instance, awards it an impressive score of 9.5 out of 10. Morningstar, a renowned authority in fund ratings, bestows a coveted 5-star rating, placing VHDYX among the top 10 percentile of funds.

For a comprehensive evaluation, Lipper, an expert in mutual fund assessment, rates funds across five critical categories: Total Return, Consistent Return, Preservation, Tax Efficiency, and Expense. Remarkably, VHDYX achieves a perfect score of 5 in each of these Lipper categories. These accolades affirm VHDYX's exceptional performance, making it a compelling choice for investors seeking excellence in multiple dimensions of fund management.

VHDYX presents investors with a choice between two investment avenues: the traditional index fund available as an investor fund, and the Exchange-Traded Fund (ETF) variant. While this fund is relatively new and doesn't offer an Admiral Class fund at the moment, the decision between opting for the ETF or index fund version is explored in detail in my accompanying article.

VHDYX, the Vanguard High Yield Dividend Index Fund, offers a compelling value proposition to investors. With an impressively low expense ratio of just 0.15%, it's 85% lower than the average expenses of funds with similar holdings. The fund also boasts a 30-day SEC yield of 2.77%, delivering an attractive income potential.

In comparison, the VYM ETF (Vanguard High Dividend Yield ETF) also shines in terms of cost-effectiveness, featuring an even lower expense ratio of 0.08%, which is 92% below the average for similar holdings. Its 30-day SEC yield stands at 2.84%, slightly edging out VHDYX.

VHDYX requires a minimum investment of $3,000, while VYM (ETF) offers a unique advantage, trading for free on Vanguard brokerage accounts, making it accessible to a broader range of investors.

It's worth noting that VHDYX is a relatively new fund and, as of now, does not offer an Admiral Class option. This highlights the importance of carefully considering the cost, yield, and accessibility factors when choosing between these two investment options.

The chart presented below vividly illustrates the impact of expense ratios on your investment returns, with the assumption of an initial balance of $10,000 and a yearly return rate of 8.49%. In this context, it's important to note that VHDYX boasts a commendably low expense ratio of 0.15%.

As per data from Morningstar, it becomes evident that the median expense ratio for comparable funds stands significantly higher at 0.89%. This stark contrast emphasizes the cost-efficiency and potential for enhanced returns that VHDYX offers to its investors. Understanding the relationship between expense ratios and overall returns is crucial in making well-informed investment decisions.

VHDYX, the Vanguard High Yield Dividend Index Fund, operates as a passively managed index fund. The distinctive feature of such funds lies in their low turnover, which typically results in limited distributions in the form of short-term and long-term capital gains. A key benefit of VHDYX's passively managed approach is the preferential tax treatment of its dividends. These dividends are classified as qualified dividends, subject to long-term capital gains tax rates that are notably lower than standard income tax rates.

Given these tax advantages, VHDYX can effectively complement both your taxable and tax-advantaged accounts, making it a versatile choice for tax-conscious investors seeking to optimize their investment returns while managing their tax liabilities.

In my taxable investment account, I hold VHDYX (a large-cap, long-term investment). For dividend investors, the typical yield expectation ranges from 2% to 4%. In this context, VYM (Vanguard High Dividend Yield ETF) stands out with a yield of 2.84%, offering a competitive return without taking on excessive risk.

It's important to acknowledge that diversification, while a valuable aspect of investing, comes with associated costs. VYM, unlike VHDYX, does not select stocks based on valuation. However, it's worth noting that in the long term, market dynamics tend to balance out such differences.

For dividend-focused investors, considering a combination of VYM and VHDYX represents a prudent strategy. These funds offer compelling options to potentially enhance your dividend income and long-term investment growth, allowing you to tailor your investment portfolio to your specific goals and preferences.

In contrast to the presence of equivalents for VDAIX and VIG in Canada, there isn't a direct counterpart for VYM (US) among Vanguard's offerings. However, Canadian investors have access to a promising alternative in the form of the FTSE Canadian High Dividend Yield Index ETF (VDY). VDY adheres to a similar investment strategy, focusing exclusively on Canadian stocks. Notably, it offers an appealing 12-month trailing twelve months (TTM) yield of 3.32%, with a minimal expense ratio of just 0.20%.

It's important to note that while VDY mirrors VYM's dividend focus, it may not match the same level of diversification. In particular, a significant portion of VDY's portfolio, approximately 64.9%, is allocated to the financial sector. This distinctive allocation highlights the nuances that Canadian investors should consider when evaluating their dividend investment options.

Source: FTSE, U.S. News, Vanguard, MorningStar and Vanguard Canada.