Q: Nancy, will you explain the fund's origin and the mission?

A: The Dividend Income Fund was started with the internal resources of Delaware in 1996. Since October 2003, the fund has been open to the public. The investment strategy of the fund is to provide a stable income stream and competitive total return to investors over a variety of market cycles. The fully invested fund does not time the markets in four sectors that we invest in. The fund has four categories of assets: 40% of the fund is in large cap value equity securities, 25% in high yield bonds, 20% in REITs, and 15% in convertible securities. We arrived at this allocation based on the analysis of the historical data on asset classes and an understanding of the volatility of each. Each of the sleeves in the fund has relatively low correlation with other asset classes in the fund. This feature offsets dramatic market swings and helps the fund ride out the volatile market cycles. Since the inception, the fund has not had a down year when measured on total return basis. The fund's stable returns are explained by the diversification across four asset classes. The four sleeves in the fund are managed by three senior managers. I am responsible for the large cap value sleeve in the fund.

Q: How do you manage the Large Cap Value sector for this fund? What are your investment criteria?

A: We manage all the sectors in the fund using our extensive research capabilities. At Delaware, we have thirteen equity analysts in the large cap value area organized by economic sectors. We use their work to determine the optimal holdings for the fund. We are looking for large cap companies that have the wherewithal to generate excess cash flow to pay dividends to investors or to repurchase stock. We are focused on companies that are shareholder-focused and are attractively valued when measured on cash flow, EBITDA and price-to-earnings ratio. In general, we have between 25 and 40 stocks. As of this interview, we had 33 stocks, diversified across sectors. The equity performance is measured against Russell 1000 Value Index. We use financial models to evaluate each company's ability to generate cash and project future growth. Our stock selection process is one stock at a time.

Q: Can you describe your research process?

A: Our goal is to identify stocks of companies that have predictable and consistent cash flow. During our selection process we do not use any forecasts in favor or against the economic outlook that aren't confirmed by the underlying fundamentals of the companies being considered. We are looking to buy companies that have a dividend yield above the market yield or repurchase a meaningful amount of their shares. We identify these companies through our fundamental and quantitative analysis. We gather our information through management meetings, competitive analysis, company visits, and industry shows. We use financial models to understand the cash flow and impact on the cash flows in various economic and market cycles. We are looking for companies that have stable cash flow during various cycles.
In meeting with management, we try to understand the macro business outlook and temperament of the management. The outcome of the meetings and financial modeling is our estimation of fair value for the stock, and this is our method of the stock selection.

Q: Will you discuss some of your recent stock picks? Why did you choose these stocks?

A: Last fall, we brought Kerr McGee into the portfolio. At the time the company had the attractive dividend yield of 4.5%. We have been following the company for several years at Delaware, and we have a good knowledge of its energy asset base in the Gulf Basin area. We had a different view on the company's stock price since we understood its Exploration and Production capabilities. The company had increased their exploration success rate, and the dividend looked safe. We viewed the catalyst for the stock as the better recognition by investors of the value of its asset base and better management of the properties and the potential spin off of the paint-related chemical business. Our extensive research helped us to have a different perspective on the company, which led us to reap investment gains.

Q: Can you share another success story?

A: Pepsico Inc. has been in the fund for at least two years. During 1999 and 2000, our dividend-based investing approach was not fashionable. We viewed the company as a good corporate citizen, and we liked the fact that the company had a 46% increase in the dividend in one year. The company has a steady cash flow to support the growth in dividends. Pepsi stock was out of favor when the company had short-term disruption in volume growth at the Frito Lay division. During that time, we added the stock to the portfolio. Since 2001, stocks with reasonable dividend payouts have done better than the market, and we have been rewarded for our disciplined investing approach.

Q: How do you measure and control investment risk?

A: We monitor securities risk at the sub-industry level across the complete fund and pay attention to sector allocation. We keep the fund diversified among sectors similar to S&P 500 and Russell 1000 indexes.

The high-yield portion of the fund has more than 100 bonds. They have 20 credit analysts, and a deep research team. There is higher level of turnover than in the rest of the fund. They take a sector-neutral approach, and BB and lower ratings are selected for the fund.

Q: Damon, what is your REIT investing philosophy?

A: We are a total return-focused investor. We do not stretch for the higher-yielding REITs just to get income. Since all REITs generate higher dividends than the broad market, we can focus on higher quality companies and still get good dividend yield.

Q: Can you describe your research approach?

A: We conduct research at three levels: financial analysis, property analysis, and qualitative analysis.

During the financial analysis, which is focused on the balance sheet and income statement, we are looking for a strong balance sheet that is not heavily leveraged. We also try to understand the quality and recurrence of cash flows. While conducting property-level analysis we look at the property portfolio. We differentiate the real estate quality from the cash flow quality. Lower-quality cash flow implies higher credit risk, but lower real estate quality does not imply higher risk. We think that kind of real estate is just a different real estate class. In the right market environment Class B property can produce higher returns than the Class A property. So we try to focus on understanding the real estate quality in addition to the competitiveness of the properties that our companies hold. Our qualitative analysis is focused on the corporate structure and management ability to formulate and execute long-term plans that will add shareholder value. Our focus is also to diversify across property types, such as multi-family, hotels, office and industrial properties, and geographic regions.

Q: Can you discuss how you pick a REIT and share with us one of your recent picks?

A: We are focused on finding companies that meet our criteria on the three research aspects I just described. We focus on the company, not the sector.