Multi-millionaire joseph Alotta of Oak Brook, Ill., is a longtime student of high-dividend investing. He’s also a true believer in the time-honored principles of Benjamin Graham.
“Value investing has proven itself time after time,” says Alotta, a CFP licensee who began managing his own portfolio after a 20-year career on Wall Street. His investments for himself and several wealthy clients include a portfolio of companies focused on dividend payers.
He manages $27 million in assets, most of which have been in the FAM Fund family since the 1980s, first in the FAM Value Fund and later in the FAM Equity-Income Fund. One of the reasons he likes the firm, headquartered in Cobleskill in upstate New York, is that its managers have their own skin in the game. FAM Equity-Income’s portfolio of mid-cap stocks all pay dividends, which Alotta says, “makes them more responsible and keeps their owners first.”
“It’s important that a company pays a dividend of at least 2%,” Alotta says. “But not too big, because maybe it’s not sustainable.”
In the current low-interest-rate environment, more yield-hungry investors and advisors are following Alotta’s path into dividend investing.
Don Schreiber Jr., the CEO of WBI Investments in Little Silver, N.J., manages $2 billion in assets for advisors and their clients using dividend-paying strategies. Schreiber, the co-author of the book All About Dividend Investing, says this is an especially good time for advisors and investors to be in dividend-paying stocks and funds.
Over the past decade, the major index companies have increased dividends dramatically. Dow Jones index companies increased dividends by 76%, S&P 500 index companies by 68% and Nasdaq companies by 490%, according to S&P Dow Jones Indices.
In the past five years, $60 billion has flowed into funds and exchange-traded funds focused on dividends, $55 billion of that in just the last three years alone, according to Morningstar’s database. Chris Philips, a senior strategist in Vanguard’s investment strategy group, explains investors have turned to dividend strategies because they are not seeing high enough yields on fixed income and because dividend payers have meanwhile enjoyed good performance over time. Value stocks, many of which are good payers, have outperformed growth stocks over the last 12 to 14 years, he notes.
Daniel J. Culloton, the associate director of fund analysis and fund research at Morningstar, says that when portfolio managers seek out names in this space, they look for high-quality companies that have above-average payouts and can also maintain and possibly increase those dividends over time (in addition to the companies’ business models, their management teams, their competitive advantages, their balance sheet strength and, to a lesser extent, secular and macroeconomic forces).
In this low-interest-rate environment, dividend strategies have become more important for advisors dealing with retirees. Wealth manager Aaron Skloff, CEO of Skloff Financial Group in Berkeley Heights, N.J., for one, is putting senior clients in dividend-paying funds.
“On the dividend side,” says Skloff, “we are specifically using BlackRock iShares Select Dividend ETF [DVY]. It has an appealing yield and low beta to the S&P 500. Our reservation is its high price-to-earnings ratio versus the S&P 500.”
Vanguard’s Philips warns that yields alone should not be the sole reason for investors to focus on dividend-paying stocks. “A dividend is only a transfer of wealth from the company to the shareholder,” he says. “You should really understand how that dividend investment fits into the rest of your portfolio.”
Financial Advisor compared and contrasted five different dividend funds, noting that different funds use different criteria to select their dividend payers.
Invesco Diversified Dividend Fund and T. Rowe Price Dividend Growth Fund
If you’re looking for a big, steady dividend fund grower, you have your choice of the Invesco Diversified Dividend Fund (LCEAX) or the T. Rowe Price Dividend Growth Fund (PRDGX). They are both defined as large-cap-value-oriented dividend payers, but they have different goals.
The Invesco fund is more than twice the size, with $7 billion in assets, while the T. Rowe Price vehicle, the older of the two, holds $3.3 billion.
Despite several down years for each fund, they both have good track records. The Invesco dividend fund, launched in December 2001, has generated an average annual return of 7.02% since inception. It has outpaced its benchmark, the Russell 1000 Value Index, in each of the five largest downturns since inception by an average of 3.90%, according to the company.
The T. Rowe Price dividend vehicle has an overall impressive record as well. From its inception in December 1992, it had returned 9.09% as of April 30, 2013.
The chief focus of the Invesco Diversified Dividend Fund is “defensible businesses with operating profit margin sustainability and prudent capital allocation,” says Meggan Walsh, who heads Invesco’s dividend strategies team and is the senior portfolio manager on the fund.
Walsh also manages the Invesco Dividend Income fund (IAUTX), whose strategy likewise focuses on companies with defensible and above-average yields. She says the Invesco Diversified Dividend Fund is especially appropriate for pre-retirees and retirees “because we manage the strategy to act as a stable foundation for investors’ portfolios, emphasizing appreciation, income and preservation over a full market cycle.”
Tom Huber, the manager of the T. Rowe Price Dividend Growth Fund, says he looks for companies to pay a dividend over time with a combination of attractive yield, lower volatility and capital appreciation. His top holdings have familiar names: Pfizer, Pepsi and J.P. Morgan.
Huber is optimistic about the future of dividend stocks. “They do well in environments of slower growth and tough economic conditions when yield matters more and growth is scarce. They tend to underperform usually in a big market sell-off.”
Payden Equity Income Fund
Both the Payden Equity Income Fund (PYVLX) and FAM Equity-Income Fund (FAMEX) have value orientations, though the Payden fund is focused on big caps and the FAM fund on mid-caps.
The Payden fund (formerly known as the Payden Value Leaders Fund), with $217.8 million in assets, is different in many respects from its peers. Its diversified mix of equity assets makes it an appealing income vehicle for many types of investors. “It is both a low-volatility equity fund and a high-quality dividend fund,” says co-portfolio manager Jay Wong.
The fund launched in November 1996. Nearly all its holdings are domestic U.S. stocks with high yields, positive yield growth rates and positive earnings growth rates.
The fund’s current yield of approximately 4.4% compares favorably with the 10-year Treasury yield of 1.9% and the S&P’s dividend yield of 2%, according to the fund.
The fund is an equity oasis at parent Payden & Rygel, which is primarily a fixed-income investment firm. As a result of an early 2011 refocus, the Payden Equity Income Fund began emphasizing high dividends, investing in several different income-generating securities, including dividend-paying common stocks, preferred stocks, real estate investment trusts (REITs) and energy-related master limited partnerships (MLPs).
“With retired investors facing lower yields today, advisory firms consider Payden’s offering a conservative way for them to get exposure to the equity market and generate an acceptable cash flow for clients,” says Sasan Faiz, co-chief investment officer for Morton Capital Management in Los Angeles, which has many retirement-age clients.
Another boon for seniors seeking a steady stream of income is the fund’s monthly dividend distribution. Its current yield is 4.5%, enough to meet their daily needs.
FAM Equity-Income Fund
Like the Payden Equity Income Fund, the FAM Equity-Income Fund has a value tilt. But there the similarity stops. As a mid-cap equity income fund, the FAM vehicle is considerably smaller than the Payden fund and the vast majority of other large-cap equity dividend funds.
Its makeup is also different. Large-cap equity dividend funds typically own household names such as goliaths Exxon Mobil, Pfizer, General Electric or Walmart. But FAM Equity-Income’s holdings are smaller, and the fund is more concentrated. Currently, it holds about 32 stocks. The value of its assets totals $135 million.
“We look for quality businesses with strong fundamentals, adept management teams, and we don’t want to pay too much for those businesses,” says Paul C. Hogan, co-manager of the FAM Equity-Income Fund at Fenimore Asset Management, the investment advisor to FAM Funds.
To protect investors from future financial crises, he says, companies must have “fortress-like balance sheets” so they don’t have to cut their dividends during the tough times.
According to Hogan, “the fund is a good fund to own for someone either outside or inside of their retirement plan.” Turnover is low, which leads the fund to be very tax efficient, since capital gains can be deferred until the holdings are sold.
Launched in 1996, the fund has enjoyed an advantage over just a handful of other mid-cap equity dividend funds. Some have sprung up only in the last year or two.
“We’ve had the space virtually all to ourselves,” says Hogan.
To the fund’s benefit, mid-cap stocks have outperformed large-cap stocks for the past several years. The fund’s holdings have increased their dividends by 11% compounded over the last five years (again, the S&P 500 saw only 2.9% dividend growth).
Huntington Dividend Capture Fund
Huntington Funds offers two different dividend vehicles: The Huntington Dividend Capture Fund (HDCTX), a high-growth dividend payer, is the older and better known of the two. The other fund is the Huntington World Income Fund (HWITX).
Nearly all the Huntington Dividend Capture Fund’s holdings are domestic U.S. stocks with high yields, positive growth rates and positive earnings growth rates.
The fund’s trailing-12-month yield of 3.85% compares favorably with the 10-year Treasury’s yield of 1.9% and the S&P 500’s yield of 2%, according to Huntington Funds.
The Dividend Capture Fund, launched in May 2001, is similar in some respects to the Payden Equity Income Fund. Both are focused on big-cap stocks with a value bent. The Huntington fund, slightly larger than the Payden fund, holds $239 million in assets.
The two funds have virtually the same diversified mix of assets. Each invests in value stocks, preferred stocks, REITs and, as a further diversifier, a sprinkling of energy-focused MLPs.
“In most markets, our relative performance is better than the market,” says portfolio manager Kirk Mentzer. “It’s because we have broad diversification [and] asset allocation adjustments, and the diversified income stream helps buffer the fund when the markets are down.”
The fund is moving away from defense-oriented stocks into more cyclical areas like energy. “Defensive areas have become quite rich and their yields are less attractive,” says Mentzer.
Like many dividend managers, Mentzer says he doesn’t necessarily look for the highest yielding stocks, but stocks that pay dividends regularly. “We’re looking for a dividend yield of 2% to 4%, the sweet spot of the dividend payers.” He says payouts higher than that are a sign of trouble.
He adds that the fund’s strategy is good for retirees. “I don’t want to see a big down market like 2008 leading to a possible erosion of principal, thus hurting retirees,” says Mentzer. In a big nod to seniors, Huntington Dividend Capture, like the Payden fund, pays dividends monthly.
“As long as the Federal Reserve and worldwide central banks keep interest rates so low, there is no place else where investors can find yield right now,” he says.
A recent entry into the field is Huntington’s World Income fund designed for investors looking for maximum yield now. The fund is currently yielding an attractive 6.5%.
As the name implies, it can scour the globe looking for the best yield opportunities, including those in emerging markets. It was launched in May 2011 and holds $36 million in assets.