20
George, a retired Chicago-area individual investor, re-
cently called me with a conundrum. He had a big
portion of his seven-figure portfolio stashed in money
market funds earning bupkis. To get a little more
yield, and maybe some appreciation, he wanted to
move some money to an equity-income fund. What
did I think of
Vanguard Equity-Income
VEIPX
?
I think a lot of the fund, and I told George so. Still,
George’s call worried me. Did he know that dividend-
paying stocks aren’t money market or bond substi-
tutes; that they could lose money; and that the strong
trailing returns of funds like Vanguard Equity-Income
didn’t presage future results? More importantly, did
he know what he would own?
A lot of income-seeking investors find themselves in
George’s predicament, and not all of them can answer
those questions in the affirmative, especially the last
one. Indeed, while George seemed to have a handle
on the risks he was contemplating taking, he was
surprised to learn the fund and other income-oriented
stock funds in recent years have edged into areas that
historically haven’t been associated with dividends.
For instance, domestic-equity funds with above-S
&
P
500
yields and records of at least
10
years currently
have more money, on average, in technology stocks
and less in financials and utilities companies than
they did a decade ago. That’s a reflection of how divi-
dend-focused managers’ opportunity set has changed
over the years. It also shows how yield-seeking
investors like George can’t take the traditional defini-
tion of equity-income stocks for granted.
“Dividend-paying stocks,” to many investors, means
utilities, telecom, consumer goods, and financial
companies. That’s still true, but more tech stocks—to
whom dividends were anathema at the turn of the
century—are distributing cash to investors now. At
the end of November
2012
, the information tech-
nology sector was the largest contributor to the S
&
P
500
Index’s yield, edging out consumer staples
stocks
14
.
6%
to
14
.
04%
, according to S
&
P indexes.
Its yield contribution has gone up from fifth place in
2010
and sixth in
2011
, according to S
&
P. A new divi-
dend from the benchmark’s largest holding,
Apple
AAPL
, accounts for much of that move, but several
other tech companies in the S
&
P, such as
Oracle
ORCL
,
Cisco
CSCO
, and
Analog Devices
ADI
, have
initiated or increased payouts in recent years.
Meanwhile, many tech stocks have languished since
their
2000
peaks, making them fair game for fund
managers who prefer dividends and low valuations.
Indeed, Vanguard Equity-Income’s tech helping
has gone from the low single digits to nearly
10%
in
the past
10
years. Other funds that put a priority
on dividend growth as well as yield, such as
Amer
ican Funds Investment Company of America
AIVSX
,
Columbia Dividend Income
GSFTX
, and
Legg Mason ClearBridge Equity Income Builder
SOPTX
, have between
10%
and
15%
in tech stocks
now. Overall, as of the end of the third quarter of
2012
, the average domestic-stock fund with an above-
market yield keeps nearly
120%
more in the tech
sector than it did
10
years ago. Meanwhile, its utili-
ties and financials stakes have dropped by
43
.
3%
and
17
.
5%
, respectively.
These changes could alter risk profiles of funds with
above-average yields, but perhaps in counterintuitive
ways. Over the long term (
10
years or more), the
Morningstar Technology Index has shown more vola-
tility than most other sectors in terms of beta and
standard deviation of returns. The credit crisis,
however, made the Morningstar Financial Services
Index the most turbulent sector over one-, three-, and
five-year periods. Owning competitively entrenched,
cash-rich companies like
IBM
IBM
,
Microsoft
MSFT
,
and
Intel
INTC
, rather than still-recovering banks
such as
Citigroup
C and
Bank of America
BAC
,
may prove to be less risky going forward. Either way,
it behooves yield-hungry investors like George
to understand where yield-oriented stock funds are
getting their income from and what risks they carry.
œ
Contact Dan Culloton at
Do You Know What Your
Dividend-Focused Fund Owns?
Income Strategist
|
Dan Culloton
