In volatile markets, dividend-focused funds shine
Fund manager Paul Magnuson only invests in companies that pay dividends, a proven but conservative strategy that analysts say requires patience.
The dividend-investing focus of the Allianz NFJ Small-Cap Value fund (PCVCX - news) kept it above the broader U.S. market last year. And Magnuson views his consistent approach as a safety net for investors in the long run.
The $5.2 billion fund has posted modest returns of 2.3 percent this year. But while the benchmark Standard & Poor's 500 Index plummeted 38 percent in 2008, Magnuson's fund posted a less dramatic 27 percent decline in total returns.
The Dallas-based asset manager attributes his fund's stability to its strategy of only investing companies that pay dividends, considered by industry professionals to be signs of a company's financial health.
"We can win by not losing," he said of his roughly 130-stock fund, which also focuses on small-capitalized companies whose share prices he considers undervalued.
Magnuson's conservative strategy reflects the broader nature of investing in dividend-paying companies, which analyst Christopher Davis says requires patience.
A dividend-focus can appear sluggish in "racier" markets, but has long-term payoffs, Davis added.
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"If these funds tend to lose less in the downside and keep up with the market in the upside, you're going to have an attractive risk-return profile," said Davis, who follows dividend-focused funds for research firm Morningstar.
From 1979 through June this year, the S&P 500's dividend-paying companies beat their counterparts by 1.56 percent per year compounded, said Howard Silverblatt, senior index analyst at credit ratings agency Standard & Poor's.
The Allianz NFJ Small-Cap Value fund has done well over the long term, posting 10-year annualized total returns of 8 percent, about 10 percentage points ahead of the S&P 500 over the same period, ranking it in the top 11 percent of its small-cap value category, according to Morningstar.
Other dividend-focused funds show slimmer returns this year but have done well over the longer term.
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T. Rowe Price's Equity Income Fund , which also has a dividend approach, has lagged the S&P 500 by about 2 percentage points this year, but is beating its large-cap value index by about 7 percentage points. It's 10-year annualized returns are about 3 percentage points ahead of S&P 500.
LIMITATIONS
There are limits to this approach, including a restriction on industries in which dividend-focused funds can invest.
Magnuson had a negligible 2 percent of his fund parked with information technology companies as of May 31, because companies in that sector are unlikely to provide regular cash payouts to investors. He favors the industrials and materials sectors, including Commercial Metals Co (CMC - news), a maker of steel and metal products that is his fund's No. 2 holding.
Commercial Metals suffered last year when commodity prices took a hit, but Magnuson liked its strong balance sheet and practice of increasing its dividend payout over the past 10 years. Its shares are up nearly 35 percent this year, compared to a nearly 1 percent fall in its sector.
S&P's Silverblatt cites another negative: while dividends can indicate a company's stability against market volatility, they are often the first expense to be cut when firms face financial pressure, he said.
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In the second quarter of 2009, 250 of the 7,000 publicly owned companies reporting to Standard & Poor's decreased their dividends, the highest number since 1957.
But those investors who can find dividend-paying stocks stand to benefit from the regular payout during times of prolonged market uncertainty such as last year's bear market.
"If we're in the doldrums, I'd rather be getting paid an income distribution from a dividend fund," said Tom Roseen, research manager at fund-tracker Lipper Inc, a Thomson Reuters company.
The need for dividend payouts becomes even more pressing as investors near retirement. "With the graying of America, people are looking for steady income streams," Roseen said.
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