NEW YORK (Reuters) - The honeymoon for dividend stocks is over.
These stocks outperformed strongly for years, following the investor-rattling financial bust of 2008.
But since the end of 2013, the returns of dividend stocks, including stodgier sectors like utilities, have been lagging the broader market, and investors have started to take notice.
Dividend stocks have long been beloved by Baby Boomers as a source of income and relatively safe investments. During periods of low interest rates, some investors see them as proxies for bonds, throwing off a few percent in annual yield while offering potential equity appreciation as well.
Yet dividend-payers tend to lose their allure during periods of robust economic growth, when investors chase bigger stock gains. And when interest rates rise, some investors swap them out of their portfolios, choosing more secure fixed-income products to deliver income instead.
While U.S. growth hasn’t exactly been robust and interest rates haven’t spiked significantly, the tide has turned so far this year with $1.2 billion in investor outflows from equity-income funds, notes Jeff Tjornehoj, head of Americas research for Lipper, a Thomson Reuters company.
That is a startling switch from 2011-2013 - when everybody wanted to take dividend-payers to the dance - with $57.7 billion in inflows over that time.
“Equity-income funds tend to give up ground when the stock market is on fire, because they don’t hold the growth names that lead the performance tables,” says Tjornehoj.
Amid stiffer headwinds for dividend-payers, picking the right individual names becomes even more important. Two equity-income funds that hauled in 2014 U.S. Lipper Fund Awards this year, for their stock picking prowess: Huber Capital Equity Income, and BlackRock Global Dividend.
The trick is not being seduced by a juicy dividend alone, says BlackRock’s Stuart Reeve, who co-manages the fund with Andrew Wheatley-Hubbard and James Bristow.
“We don’t just target yield,” he says. “It’s only a great investment opportunity if you combine an attractive yield with sustainable and consistent growth. That will deliver a combination of yield and capital appreciation.”
After all, some companies crank up their dividends to lure in income-hungry investors and cover up deeper balance-sheet troubles. In contrast, Reeve seeks out high-quality businesses that have not inflated their dividends to unsustainable levels.
One example: Imperial Tobacco Group PLC, which he sees as a virtual cash machine that is attractively valued.
Reeve also likes perennial dividend giant Coca-Cola Co, as a well-run operation that is willing to explore new business avenues, such as its recently announced partnership with Keurig Green Mountain Inc.
Indeed, the BlackRock fund’s portfolio is heavy on such megacaps, with a particular taste for companies in the consumer goods sector. And since it is a global fund, managers are free to roam for the right investments: Favorite locales include the United States (40 percent of the portfolio), the United Kingdom (18 percent), Switzerland (11 percent) and France (7 percent).
The approach has translated into 3-year annual returns of 12.23 percent through March 18, beating the MSCI EAFE benchmark that returned 9.85 percent a year for the same period.
Both of these Lipper Award-winning equity-income funds boast turnover rates that are well below the category average, notes Lipper’s Tjornehoj. That means the managers have a yen for locating long-term success stories and then sticking with them, in the spirit of Warren Buffett’s buy-and-hold philosophy.
Joe Huber, who manages the Huber Capital Equity Income fund for his El Segundo, California-based Huber Capital Management, says he looks beyond business fundamentals to human nature, which endows most of us with terrible investment instincts.
He applies behavioral finance principles in generating his picks, countering the human tendency to chase returns and hold onto losing stocks in the hopes of a turnaround.
Apparently the strategy is working for him: As of the end of February his fund boasted 1-year returns of 28 percent, compared to 25.4 percent for the Standard & Poor’s 500 index. The 5-year figures are even more impressive, racking up over 32 percent annually, beating the S&P 500 by 7 percentage points a year.
Huber’s top holdings as of the end of 2013 include dividend stalwarts like tobacco giant Philip Morris International Inc, with its 4.7 percent yield, and utility Exelon Corp, currently yielding 4.2 percent.
Of course, Huber is the first to admit that he harbors decision-making flaws as well, even though another fund he manages, Huber Capital Small Cap Value, also managed to pull down a Lipper Award this year for its top performance.
“I make cognitive errors just like everybody else,” he says. “But if you know you have a bias, and can admit it, then you can build a process to adjust for it. And even if other funds start recognizing that as well - I already have a 20-year lead in capitalizing on it.”
(The writer is a Reuters contributor. The opinions expressed are his own)
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Editing by Beth Pinsker and Sophie Hares)