Dividend funds offer more than routine
April 11, 2007
NEW YORK — Dividend funds once held an image of a reliable teammate — not a player languishing on the bench but also not the one drawing accolades from fans.
But dividend funds can be more than a reliable investment paying dividends even when stocks themselves are sputtering; not only do their underlying stock prices offer the chance for appreciation, the dividends themselves may also be on the rise.
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Companies that pay dividends and the funds that track them have grown more attractive to some investors since lawmakers reduced taxes dividends face in 2003.
Judith Saryan, a portfolio manager at Eaton Vance Investment Management, said dividends are also now seen as a more wise use of a company's cash.
"One of the best things a board of directors can do to show a company is healthy is to pay and to grow a dividend," she said.
"Companies were just chasing capital appreciation at all costs. They really did not focus on dividend growth, so we had a decade in the 1990s where dividends didn't really contribute much to total return."
Saryan, who helps run the Eaton Vance Tax-Managed Dividend Income Fund, contends some investors now look at dividend funds as a partial substitute to bonds. While she cautioned that stocks are naturally more volatile than bonds, she notes that more companies in the Standard & Poor's 500 have begun paying dividends and have more readily increased the amount of the payments since the tax-law changes.
"If you're a dividend-focused fund, your hunting ground tends to be the kind of companies that are in the S&P 500," said Christopher Davis, an analyst at investment research provider Morningstar Inc.
The large companies of the S&P 500 are different from, say, startup technology companies that often choose to reinvest their money in the company rather than make a payment to shareholders.
Not all small companies are overlooked by dividend funds, however. Some funds concentrate on dividend growth rather than the current size of the payments.
"If you can find companies that you think have a high likelihood of consistent and significant dividend increases for a long time to come then you've got some real potential," said Donald Taylor, a co-portfolio manager at the Franklin Rising Dividends Fund.
He contends, for example, that a company with a dividend yield of 2 percent and with sizable potential could be a better bet than a company with a 4 percent yield but with less hope for growth.
"I'll sacrifice some current yield for confidence in long-term dividend growth prospects."
Traditionally, dividends were favored by retirees who depended on them to supplement their income. Taylor noted that investors not soon facing retirement perhaps wouldn't immediately need the income brought by bigger dividends — but that doesn't mean these aren't good investments for them. Even if retirement isn't nearby, investors uneasy about the economy's direction might find some security in them, he said.
"In weaker markets there generally is a focus on dividends and in periods of volatility they have held up pretty well," Taylor said.
Davis noted that because many mutual funds incorporate the word "dividend" into their names, investors "have to look under the hood" to determine whether a fund is appropriate for them.
"A dividend going from 2 cents to 5 cents is an increase but it's not going to yield much. It's not going to pay the rent."
Davis said investors should also be careful about choosing a dividend fund simply because it has a high yield.
"You want to make sure the fundamentals underlying that fund are sound. Don't be bamboozled by a high yield, or a high star rating or by flashy short-term returns because they may not tell the whole story," he said.
Dan Genter, president and CEO of RNC Genter, said when considering whether to invest in a dividend-paying stock he focuses on the company's balance sheet, its commitment to maintaining and increasing a dividend as well as the strength of company's growth prospects.
He said that while many investors once simply debated what mix of stock and bond funds to hold, some are increasingly looking to shoehorn dividends funds alongside other investments as the possibility of a lengthy retirement increases.
"Where 15 years ago pulling in the horns would've meant going to fixed-income, now it means you just go a more conservative asset class."
