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Dividend funds show long-term strength

Over the past 15 years, they have outmuscled their equity-fund rivals

INVESTMENT REPORTER

In the waning years of the last millennium, dividend and bond fund managers might as well have been fossils wallowing in a primordial ooze for many investors.

One bear market later, however, and those same managers look more like the action heroes of mutual-fund investing.

Over the past 15 years, dividend funds have outmuscled their equity-fund rivals. For the decade and a half ended Sept. 30, Canadian dividend funds posted average annual gains of 8.7 per cent, beating by a couple of percentage points the 6-per-cent average for the Canadian equity group. Even staid old bond funds brought in an average return of 8.5 per cent. The S&P/TSX total return index rose an average of 5.7 per cent annually over the same period.

"Three or four years ago, you couldn't get somebody to touch a dividend fund," says Raynor Burke, analyst at National Bank Financial Corp. "I think it's too bad that dividend funds were overlooked for so long even though they were a great place to be invested. Now they're high fliers."

As Mr. Burke notes, funds that invest in dividend-paying stocks, bonds and income trusts tend to lack the glamour and spectacular returns that drew so many investors to technology and growth stocks in the late 1990s.

But dividend funds have added appeal during the volatile markets of recent times: Even if the price of a stock falls, the dividend it pays provides a cushion.

And even when sagging, they stayed plumper than equity funds. Over the past 15 years, Canadian dividend funds recorded their worst performance in the year ended Sept. 30, 1990, when the average fund lost 7.8 per cent. The worst tally for the Canadian equity category: a loss of 18.9 per cent in the year ended Sept. 30, 2001.

More recently, Canadian dividend funds slipped 1.5 per cent for the year ended Sept. 30. Canadian equity funds dropped an average of 8 per cent.

Dividend fund holders haven't lagged by much on the upside either: the best year for the category ended Sept. 30, 1997, when the average fund chalked up a 30.1-per-cent return -- not far behind the average 34.8-per-cent jump of Canadian equity funds for the year ended Sept. 30, 2000.

Tighe McManus has guided the $5.6-billion Investors Dividend Fund to an average annual compound return of 8.6 per cent over the past 15 years. Mr. McManus looks for a mix of Government of Canada bonds, as well as preferred shares and common stocks that pay an above-average dividend yield. He also makes preservation of capital a top priority.

"[Unitholders] know that they will not wake up one morning and find that I have ever taken a flier on anything. If you want a fund with more juice in it, you should be in a different fund."

At the moment, he's buying stocks during market downturns but standing when the market regains some strength. His cash holdings stand at 15 per cent so he can take advantage of sell-offs.

Mr. McManus holds interest-sensitive stocks such as banks and utilities but he also holds names that rise with an improving economy, such as Thomson Corp., Dofasco Inc., Imperial Oil Ltd., and Shell Canada Ltd. "The fund has a natural hedge," he says.

Bill Procter, manager of the $183.2-million Maxxum Dividend Fund offered by Mackenzie Financial Corp., which has an average annual compound return of 10.7 per cent over the past 15 years, believes dividend funds are bound to do well because they invest in companies that are more profitable to start with and have been able to maintain that superiority over time.

Some investors may worry about chasing the hot recent performances of dividend funds, and Mr. Procter says a sudden stock rebound may leave dividend funds behind in the short term because the staid and steady names don't fluctuate as wildly. "If the market is up a lot in a short period of time, it's often the high-beta stocks that have gone up."

Income trusts, meanwhile, have performed extremely well, and Mr. Procter says they may be "a bit frothy" after all the investor interest. But he still believes careful selection can turn up income trusts that are not overvalued.

Mr. Procter is also optimistic that some dividend-rich sectors will perform well, including the banks. He thinks the worst of the loan-loss provisions are behind Canada's chartered banks and that earnings should look better next year as a result. Valuations on bank stocks look very good compared with Government of Canada bonds, he adds.

As Mr. Burke points out, companies that offer a dividend bolster investor confidence because giving money to shareholders suggests management has faith in its earnings quality, Mr. Burke says.

Beyond that, he adds, paying out cash also instills good corporate discipline. Once management has committed a certain dividend, executives are generally loathe to cut it because shareholders will brutally punish the stock price.

But while Mr. Burke believes most investors should allocate a portion of their portfolios to dividend and fixed income securities, he doesn't recommend they abandon growth and value equity funds, because those can race ahead when the market is hot.

"You do need that little extra horsepower long-term in your portfolio," he says, adding, "you could go through an extended period when fixed income isn't performing well."

Dan Hallett, an analyst at Sterling Mutuals Inc., notes that dividend and bond funds have outperformed over the past 15 years because financial markets have seen a long, downward trend in interest rates over that time. He estimates that interest rates have come down 500 basis points since 1990.

Mr. Hallett also believes that dividend and bond funds belong in most portfolios.

Investors who want a core equity holding should look for a fund with lots of common stocks. Mr. Hallett points to PH&N Dividend Income-A and Standard Life Canadian Dividend Growth as solid performers.

Investors looking for income should seek out funds that contain higher-yielding securities, including a mix of common and preferred shares and income trusts.

Mr. Hallett recommends Dynamic Dividend, GGOF Monthly Dividend Fund Classic and CI Signature Dividend.

Low fees are a significant factor in choosing a bond fund, says Mr. Hallett, suggesting PH&N Bond-A, Perigee Active Bond, McLean Budden Fixed Income and Beutel Goodman Income.

© 2007 The Globe and Mail. All rights reserved.

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