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Equity dividends are popular—maybe too popular.
Their popularity has grown since the financial crisis
because bond yields, despite rising this year, still
remain low in absolute terms. In seeking an answer
to one conundrum, however, income-seeking inves-
tors may be creating another—by chasing stocks with
yield, they’ve driven up valuations and increased risk.
Funds that invest in dividend-paying or higher-yielding
stocks have been among the few kinds of equity
funds to consistently attract inflows over the past five
years. They’ve lagged the market in strong recent
years like
2009
and
2013
, but because they held up
well in
2008
and
2011
, their valuations are looking
full. Areas of the market to which typical investors
turn for yield, such as consumer staples and utilities,
look rich. The high-teens average price/earnings
ratios of the Morningstar Utilities and Consumer De-
fensive indexes are higher than they’ve been since
2007
and above that of the broad stock market. The
average P/E of the Morningstar Dividend Yield
Focus Index was also at a multiyear high of nearly
16
at the start of December
2013
.
This leaves investors in a tough spot. With the
10
-year
Treasury at about
2
.
9%
and other bonds offering
low yields, stocks still figure to be a big part of most
income-seeking investors’ portfolio mix. With valua-
tions looking full in income-generating stock sectors,
however, they may be adding price risk by focusing
on yield now.
Shunning dividend-paying stocks altogether isn’t a
viable option for investors who value them for their
income-producing and long-term-compounding
potential. Investors can mitigate some of the risk by
focusing on quality, though. To help identify the
dividend-focused funds with the highest-quality port-
folios, I ranked and scored such funds by quality
measures like average debt/capital ratio and by per-
centage of assets in stocks that Morningstar equity
analysts think have wide moats, or sustainable com-
petitive advantages. Here are a few that scored
well and could offer dividend exposure with some
downside protection should the market turn against
equity yield.
Amana Income
AMANX
is a little pricey, but
manager Nicholas Kaiser has a great long-term record
here and at
Amana Growth
AMAGX
. The fund
invests according to Islamic principles, so it avoids
companies with a lot of debt and scores well on
portfolio quality.
Vanguard offers a number of solid dividend-paying
options. Passive investors can choose from
Vanguard
Dividend Appreciation
Index
VDAIX
and
Vanguard
High Dividend Yield Index
VHDYX
in open-end or
ETF
format. Vanguard High Dividend Yield owns more
of the richly valued utilities sector, so I’d lean toward
Vanguard Dividend Appreciation because it shuns
that area and tracks stocks with long histories of divi-
dend increases.
Vanguard Dividend Growth
VDIGX
is one of Morningstar’s favorite dividend-focused
funds. It has more than
60%
of its assets in wide-moat
stocks, more than any of the dividend-focused funds
in the M
500
.
Vanguard Equity Income
VEIPX
manager Michael Reckmeyer buys stocks with higher-
than-market yields but won’t pay up for yield or stint
on growth.
T. Rowe Price Dividend Growth
PRDGX
is an
epicure when it comes to dividends. Manager Tom
Huber doesn’t swear off high yield or low yield, or
new or even no dividend payers, but invests in all of
them in moderation. The result is a diversified port-
folio of cash-generating stocks that tends to fare well
in a variety of market conditions.
These funds stand a good chance of holding up better
than peers who chase yield for yield’s sake. Moreover,
they’re good long-term holdings for investors who
not only want income but also income that can grow
over time.
œ
Contact Dan Culloton at
Looking for Dividends and Quality
in One Package
Income Strategist
|
Dan Culloton
