(The opinions expressed here are those of the author, a
columnist for Reuters.)
By John Wasik
CHICAGO May 5 One of the few consistent,
although hardly glamorous, strategies in global investing has
been companies that routinely raise their dividends.
Although few of these companies will excite your imagination
- they are mostly the old-timers of American public companies -
they combine steady income and a dollop of growth, allowing you
to not only lower risk but also boost your income.
Yet investing in these companies can be difficult because
you need to do a lot of homework to gauge whether they will
continue to raise their dividends. For many investors, an index
fund may make sense.
This is one area where scrutinizing internal fund management
can reap higher returns.
I've always liked dividend appreciation exchange-traded and
mutual funds because they can track the companies most likely to
keep raising their dividends. In a dismally low-yield climate,
the combination of growth and income is a welcome respite.
But you have to be aware of the differences among these
funds. They are subtle, yet worth noting if you want some
flexibility and higher returns.
THE BIG GUNS
The heavyweight in this category of more than 70 funds is
Vanguard's Dividend Appreciation Index ETF, which I've
recommended in the past. It holds $19 billion in assets.
Vanguard's fund not only tracks companies that have raised
their dividends in each of the past 10 years, it drops stocks
that might cut their payouts. The fund yields about 2 percent
and has gained nearly 16 percent for the 12 months through May
2. It's up 1 percent year-to-date and charges a meager 0.10
percent annually for management expenses.
A worthy competitor is another Vanguard product - the
Vanguard Dividend Growth Fund, which is up nearly 17
percent for the past 12 months through May 2 and 2 percent
year-to-date. Its yield is just under 2 percent, and it charges
0.31 percent for annual expenses.
While the funds have similar objectives and the growth fund
charges three times more for management, the growth fund's
returns have been two percentage points higher over the past
three years. That's because nearly two-thirds of the growth fund
is weighted toward stocks in just four sectors: healthcare,
industrials, consumer defensive and consumer cyclical.
What's special about these sectors? They've mostly been in
favor as the United States works through its sluggish recovery
and market movers remain skittish about the possibility of
higher interest rates. The appreciation index fund has nearly
half its portfolio's holdings in industrials and consumer
Placing your bets this way works in some markets but not in
others; sectors fall in and out of favor like middle-school
friendships. The strategy succeeds only if managers can tweak
their portfolios to time undervalued sectors and downplay them
once they fall out of favor.
For a more evenly weighted dividend growth approach,
consider the FlexShares Quality Dividend ETF, which has
no more than 14 percent of its holdings in any one sector.
Charging 0.38 percent in expenses, it sports a somewhat higher
yield than the Vanguard funds at 2.5 percent. The fund is up 20
percent for the 12 months through May 2 and almost 3 percent
The larger takeaway is that focusing on dividend payers
today still makes sense in a slow-growth economy. According to
the most recent FactSet Dividend Quarterly Report, the S&P
dividend payout ratio - the percentage of companies paying
dividends - "remains one of the highest non-recession levels
And with traditionally cash-rich but dividend-stingy
technology companies starting to pay and increase their
dividends, the story gets better. By the end of 2013, the tech
sector's number of dividend payers had increased by 68 percent
sincd 2002, according to FactSet.
As the economy continues to improve, dividend payers will
have more cash to convert to shareholder payments. Consumer
discretionary stocks are expected to lead the way in dividend
growth, followed by financial companies, according to FactSet.
It's important to remember that in exchange for the
reliability of dividend payments, you're not getting full
stock-market-index returns. The Vanguard Dividend Appreciation
ETF, for example, has lagged the broad S&P 500 index over the
past one to five years by roughly 2 to 4 percentage points,
depending on the period.
But what you sacrifice in terms of appreciation, you gain in
the form of lower volatility.
Dividends provide a modest buffer in the worst markets
because they offer steady cash payments to investors. In 2008,
when the S&P lost 37 percent, the Vanguard appreciation fund
lost only 26 percent. That's not a risk-free return by any
means, but a dividend strategy continues to make sense if you're
concerned about mixing appreciation with income. The combination
of growth and dividends trumps bond returns in most years.
(Follow us @ReutersMoney or here
Editing by Douglas Royalty)