UPDATE 1-Managers sell highest paying dividend stocks
*Managers say highest paying dividend stocks too pricey
*Selling utility, telecom stocks
*Concerns that 'halo effect' is driving up prices
By Jessica Toonkel
Dec 19 (Reuters) - Since the financial crisis, money managers had flocked to high-paying dividend stocks, lured by one of the only bright spots in the volatile U.S. equity market. Not anymore.
Investors -- especially retirees and those close to retirement -- are desperate for income in a market where Treasuries are yielding close to nothing. Dividend-yielding stocks, generally low-risk and with a track record of providing solid streams of incomes over time, have been a favorite of money managers.
But now, T. Rowe Price Associates , Bank of New York Mellon Corp and AllianceBernstein LP are part of a growing group of asset managers dumping some of these stocks because they believe they are too expensive.
Managers are moving money out of utilities, telecom stocks and, in some cases, master limited partnerships. They say that these stocks -- traditionally resilient in market downturns -- are so pricey that they may not rebound if markets decline.
"If there is another downturn, I don't think they will be as defensive as they have been historically given how expensive they are," said David Giroux, portfolio manager of T. Rowe Price's Capital Appreciation Fund .
Money managers are instead buying lower-dividend yielding stocks in sectors like health care, industrials and energy, where they see more potential for growth regardless of market conditions.
Through November, investors poured $28.7 billion into equity income funds, which invest in dividend-paying stocks, up four-fold from the first 11 months last year, according to Strategic Insight.
On its face, the move seemed wise.
Utility stocks have been producing a 5.5 percent yield and telecom stocks are yielding 4.2 percent. They are an attractive alternative to Treasuries which are yielding about 2 percent. The Standard & Poor's 500 Index has not done much better, paying dividends of about 2.3 percent, according to Standard & Poor's Capital IQ.
That premium comes at a price. Utilities and telecom stocks are trading 14 to 16 times 2012 earnings estimates, compared to the S&P 500, which is trading at 11 times estimates, according to Capital IQ.
"People are so focused on yield that they are willing to pay 14 to 16 times earnings," for a stock, said Giroux. "Anything above the benchmark index is considered a premium.
The rush to dividend stocks has created a "halo effect", which could dissipate once the uncertainty around the European debt crisis, said Vadim Zlotnikov, chief market strategist, at AllianceBernstein. He believes high-yielding dividend stocks are an expensive and "crowded" trade.
AllianceBernstein moved from neutral to underweight on telecom and utilities stocks in September. The firm has been increasing its allocation in healthcare stocks, particularly pharmaceuticals like Pfizer Inc and Medtronic Inc .
It is a strategy designed to capture companies that might raise their dividends in the coming year. Medtronic, which is yielding 2.7 percent, is more likely to increase its dividend than the highest-paying dividend stocks, Zlotnikov said.
Early this year, the T. Rowe Capital Appreciation Fund, went underweight the top quintile of highest paying dividend stocks. But in the past month, Giroux has also reduced his holdings of the next tier of dividend-yielding stocks, such as regulated utilities with high high payout ratios, telecom and some consumer staples. It is the first time in more than two years the fund has been underweight these stocks, he said.
Giroux declined to name the companies he has sold.
CUT UTILITY EXPOSURE
BNY Mellon Wealth Management is bullish on dividend stocks overall, but has cut its exposure to utilities and master limited partnerships they have deemed too expensive, said Leo Grohowski, chief investment officer.
For example, the current yield of the Alerian MLP Index is 6.3 percent. The forward price-to-earnings multiple for the industry is 22 times earnings. But the historical five year average is 20 times earnings.
"Why is the P/E multiple so high? It's because investors are not focusing on price valuations... they are only enamored by the yield," Grohowski said.
Grohowski prefers energy stocks, which are paying 3 to 5 percent yields but have single-digit P/E multiples.
While managers said they are cutting back on the most expensive dividend yielding stocks, most say they still expect strong performance from dividend stocks in 2012.
Grohowski said he expects dividend growth to be up 20 percent, year-over-year. Similarly, Zlotnikov believes even the most expensive dividend stocks will perform well in the short term as the uncertainty around euro zone debt issues linger.
"Over the next three months the 'halo effect' will stay in place," he said. "But over the next one to three years, things may change."
(Additional reporting by Sam Forgione)
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