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This Dividend-Focused Fund Stands Apart

Silver-rated Neuberger Berman Equity Income favors income staples such as utilities and REITs, as well as convertible bonds.

The following is our latest Fund Analyst Report for Neuberger Berman Equity Income (NBHIX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days. 

Neuberger Berman Equity Income has proved its worth over a full market cycle and earns a Morningstar Analyst Rating of Silver.

The fund benefits from veteran leadership and a consistent approach. Comanagers Rich Levine and Sandy Pomeroy, who have helmed the fund since its 2006 inception, strive to generate a current yield greater than the S&P 500's average while providing some opportunity for equity-market upside. They achieve both goals. The fund's trailing 12-month yield of 2.7% in September 2018 placed in the highest decile of the large-value Morningstar Category, and its 7.8% annualized gain from its November 2006 inception through September handily beat the category's 6.2%.

The managers' approach is distinctive and well-executed. They build a value-focused portfolio featuring dividend-paying large-cap stocks, but the fund looks unlike any other in the category and strays far from any market index. Utilities and REITs play a major role here. Each tends to occupy 15% to 20% of the fund's assets while representing just 2% to 3% of the S&P 500. Other dividend-paying stocks, diversified across sectors, make up another 50% to 60% of the portfolio. The bulk of the remaining assets is stashed in debtlike convertible bonds, which over the past five years have accounted for 3% to 12% of the portfolio. The allocations to convertibles, utilities, REITs, and other dividend-paying stocks are opportunity-driven and have varied widely since the fund's inception. For example, the managers adeptly pivoted away from stocks during the first quarter of 2008--ahead of the equity market's steepest drops--and loaded up on convertibles, which reached nearly 40% of the fund in 2009.

Over the long haul, the team's asset-allocation and stock-picking skills have produced strong risk-adjusted results. The fund's since-inception Sharpe and Sortino ratios eclipsed those of the S&P 500, the FTSE High Dividend Yield Index, and large-value category. The fund’s income mandate leaves it prone to short-term underperformance when interest rates spike, as in 2016. But its strong management and sound approach make it a good long-term choice.

Process Pillar: Positive | Robby Greengold 10/03/2018

The execution of this total-return approach merits a Positive Process rating.

The managers pursue yield and modest equity-market upside by constructing the portfolio atop a foundation of four sleeves: convertible bonds, utilities stocks, REITs, and other dividend-paying stocks diversified across sectors. The "other" sleeve is most prominent; it can account for up to about 60% of the portfolio, while the rest are each capped at 40%.

Idea generation for the fund’s equity portion starts with a quantitative screen. The team sifts a broad basket of global stocks to find firms with market caps of at least $2.5 billion and dividend yields exceeding 2.5%. Dividend sustainability is paramount here, so the managers look for stocks with ample free cash flow and healthy interest coverage. Rigorous fundamental research is then used to assess companies’ industry attractiveness, capital allocation track records, market supply/demand dynamics, among other considerations. The team projects upside and downside scenarios via discounted cash flow modeling. Stocks with the most attractive risk/reward profiles, as estimated by the team, are added to the portfolio. For convertible bonds, the managers look for out-of-the-money issues with maturities of three to seven years. Distressed and equitylike convertibles are avoided.

The managers collect additional income by tactically writing covered calls and selling puts.

Few fund portfolios look like this one. In July 2018, equities consumed roughly 90% of the fund’s assets while convertible bonds accounted for most of the remainder. Individually, the utilities and real estate sectors occupied 15 percentage points of the equity share--much higher than the S&P 500’s stakes of 2%-3% each. Those heavy allocations push other sectors aside--the portfolio’s tech weighting of 13% in July was half the index’s. The fund best fits in the large-value category but further distinguishes itself by investing across styles and market caps.

The managers often find attractively valued dividend payers overseas. Since early 2013, the fund's foreign stake has ranged from 5%-30%. Most of these holdings are developed-markets multinationals that pay stout dividends, like Rio Tinto PLC RIO.

The sleeve allocations are opportunity-driven and have varied widely in the past. Ultralow interest rates in recent years have soured the relative attractiveness of convertible bonds, the managers think, explaining the asset class’s staid portfolio share of about 10% over the past half-decade. Convertibles have historically made much more of a showing. For instance, when markets were reeling from late 2008 to early 2009, deep discounts found across the convertible-bond market induced the managers to invest nearly 40% of the portfolio in convertibles.

Performance Pillar: Positive | Robby Greengold 10/03/2018

The fund's Positive Performance Pillar rating reflects its stable returns and muted risk profile. Since its November 2006 inception, the fund's 7.8% annualized gain through September 2018 placed in the large-value category’s top quintile. Over the same period, the fund's Sortino ratio (a risk-adjusted metric that penalizes downside risk) ranked in the category’s top decile.

The managers’ focus on financially healthy dividend payers has helped limit the fund's losses in faltering markets. In the 2008 credit crisis, the fund's 22% calendar-year loss beat the S&P 500 by nearly 15 percentage points and placed among the category’s top 2%. The fund also had a top-decile 5% gain amid turbulence in 2011 and held up better than 85% of peers during the Nov. 3, 2015-Feb. 11, 2016, correction.

The corollary of the fund's superior showings in down markets is that it tends to lag in rallies. The fund's 2009, 2012, and 2013 calendar-year returns each finished in or near the category's bottom quarter.

The fund's income orientation can make it sensitive to short-term interest-rate spikes. That happened during 2013’s taper tantrum and in 2016’s second half, when the 10-year Treasury’s yield shot up about 120 basis points between July 8 and Dec. 15. The fund lagged more than four fifths of peers during that stretch.

People Pillar: Positive | Robby Greengold 10/03/2018

Capable leadership and a stable team earn the fund a Positive People rating.

Rich Levine and Sandy Pomeroy have comanaged the fund since its 2006 inception. Each has more than 30 years of industry experience. Levine joined Neuberger in 1989, before which he was a tax attorney and financial planner. Pomeroy came to the firm in 2005 after spending five years at JPMorgan and five years at Brown Brothers Harriman. Associate portfolio manager Will Hunter took his post at this fund in late 2012. He joined the firm in 2006 after spending four years at JPMorgan. He splits his time between this fund and Neuberger Berman Dividend Growth NRDGX, which he also comanages.

The trio is backed by a dedicated analyst, a broader income-focused team composed of veteran dividend-focused portfolio managers, and a centralized analyst pool populated by several dozen sector specialists.

This fund's dedicated personnel share a collaborative culture with those managing Neuberger Berman's other income strategies and are collectively dubbed The Messinger Group. The group gathers weekly to review recent portfolio company meetings, share information gleaned from previous trading days, and re-evaluate assumptions used in their financial models.

Pomeroy invests more than $1 million of her own money in the fund, while Levine and Hunter have lesser sums invested.

Parent Pillar: Positive | 11/08/2017

Neuberger Berman’s steady approach to its evolution earns the firm a Positive Parent rating.

The firm, founded in 1939, emerged from the collapse of Lehman Brothers with new capabilities and a new ownership structure. Lehman’s fixed-income and private-equity acquisitions became part of Neuberger Berman in the wake of Lehman’s 2008 collapse, when chairman and CEO George Walker led employees in taking the more diversified firm private. Over 460 employees now own the business, which manages $270 billion in assets.

Once known primarily as a U.S. value equities shop, the new Neuberger Berman sees growth opportunities in Europe and Asia. Clients in those regions own 30% of the firm’s assets under management. Although solely an investment manager, its retail mutual funds make up only one fifth of business. The rest is institutional and private client money, long bastions of the firm’s identity.

The firm has lifted a few teams out of other firms to expand its circle of competence, including a talented emerging-markets-debt team from ING in 2013. While the firm has been selective in its acquisitions, its hands-off approach lets the new teams do what they do best. Meanwhile, the firm’s partnership structure allows these new teams to integrate more fully into Neuberger by becoming managing partners over time.

Price Pillar: Neutral | Robby Greengold 10/03/2018

Fees across the mutual fund industry have been on the decline, while this fund’s net expense ratios have barely budged. The fund’s Price Pillar rating has dropped to Neutral from Positive because its latest fees were roughly in line with most rivals’.

The Institutional shares, which hold nearly three fourths of the fund’s assets, charge 0.69%. That undercuts the median for similarly sold funds by 4 basis points, but not by enough to merit enthusiasm.

The fees charged by the C, A, and R3 share classes are similarly uncompetitive.

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Robby Greengold does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.