- The Washington Times - Monday, July 5, 2004

Get ready to start paying attention to another number in your equity mutual fund portfolio: yield.

Stock funds aren’t typically associated with income, but with more companies paying out dividends, Wall Street has a renewed enthusiasm for dividend-focused mutual funds. A tax cut last year also helped increase their popularity.

Regular dividends are often viewed as a good sign of financial health. Companies that pay them are usually larger, less-risky value stocks with stable balance sheets. For long-term investors, dividend-focused mutual funds can provide a welcome element of steady growth.

“Unless there’s an investment opportunity that would increase shareholder value, a dividend is a pretty good thing for a company to do with its money,” said Paul Herbert, senior mutual fund analyst at Morningstar Inc. “You can bank on a dividend.”

During the go-go years of the technology boom, when overnight profits were all the rage, many investors preferred not to bother with the dull growth of dividends, and some companies stopped paying them altogether. In 2002, only 350 companies in the Standard & Poor’s 500 paid dividends. That number has climbed to 376 now, but it’s still far from the 469 that paid dividends at the end of 1980.

It’s not a new idea for a fund to focus on dividend-paying stocks, Mr. Herbert said. Most mutual fund shops, including T. Rowe Price, Fidelity, Vanguard and American Funds, offer dividend growth or equity income funds. For more conservative investors, these can be good core funds, because the stability of their underlying holdings make them less volatile.

“I think it’s good to start with a first fund that isn’t going to get whacked around. Equity income funds tend to hold up pretty well,” Mr. Herbert said. “Some of our favorite funds have practiced a dividend focused strategy for a long time.”

The holdings of these funds depend largely on the individual manager’s style, and may not even be limited to companies that pay dividends. As a rule, however, dividend growth funds tend to focus on higher-quality growth companies with a good history of consistently raising their dividends. Equity income funds are usually more concerned with producing a very competitive current yield relative to the S&P; — currently about 1.6 percent. In both cases, the focus is on total return, meaning all of the income derived from dividends, capital gains and share price fluctuations.

Since 2001, dividends have made up about 26 percent of total return for the S&P; 500. Historically, dividends have made up about 41 percent of total returns. In the late 1990s, however, the figure dipped into the single digits.

During that period, companies wanted to do whatever they could to boost their share prices. There were tax benefits for share repurchase programs — in which corporations buy back their own stock on the open market, lowering the number of shares outstanding and raising their value — so companies were less inclined to pass excess capital to investors in the form of dividends.

Last year’s tax law changes put share buybacks and dividends on equal footing, however. It also cut the amount of tax investors pay on dividends to 15 percent; before, dividends were taxed as ordinary income.

“In the late ‘90s and 2000s … yield wasn’t necessarily the best place to find returns, which was a different message from what most of history tells us,” Bartlett R. Geer, manager of the Putnam Equity Income Fund, said. “With the tax bill and the change in the market, we would anticipate that yield investing will come back into favor.”

For investors focused on current income, equity fund yields still are no match for bonds. Few stock funds, regardless of their holdings, have yields higher than 1.5 percent. At that level, the annual yield return on an investment of $10,000 would be only $150. In most cases, however, equity income or dividend growth funds will reliably produce a higher yield than money market funds.

In the current climate, a more conservative investor might like to combine short-term bonds with dividend paying stocks. An example is the Hennessy Balanced Fund, which invests equally in one-year U.S. Treasuries and the 10 highest-yielding stocks on the Dow Jones industrial average, known as the “Dogs of the Dow.” Another dividend-focused Hennessy Fund, Cornerstone Value, contains 50 high-yielding stocks.

“It’s not what you make on the upside, it’s what you don’t lose on the downside,” said Neil Hennessy, the group’s president and portfolio manager. “When you’re starting out, you can take the volatility, you’re fine. But as you build a nest egg, you want less volatility. … J.P. Morgan, General Motors, Dupont, Citigroup, Exxon. … These stocks are going to be around a long time.”


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