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Looking for bright stars in a small universe

Income-earning funds draw from a limited pool of stocks, so look beyond their shiny veneers, KEITH DAMSELL writes


The Canadian dividend fund, an elusive and easily misunderstood asset class, is perhaps the most important choice a mutual fund investor will make.

A blue-chip dividend fund is an essential core holding, and it can make or break an investor's returns. For most investors, the fund class may represent anywhere from 15 per cent to 30 per cent of the value of a portfolio.

"Dividend funds are a great core, long-term investment for any investor's portfolio," said Olivia Woo, vice-president and investment counsellor at T.E. Investment Counsel Inc. in Calgary. "If you look at which stocks appreciate the most over the long term, you'll likely see those with high dividend yields."

Yet it's a very narrow segment of the market. Only about 186 of the 273 companies that make up the Standard & Poor's/Toronto Stock Exchange 300 index generate dividends. In other words, it's a relatively small universe of equities for the 232 funds that make up the Canadian Dividend and Equity Income class to choose from.

"Dividend funds all drink out of the same pond -- large cap Canadian stocks. As such they have the risks inherent in that pond," said Chris Reynolds, president of Investment Planning Counsel Inc., a Mississauga-based wealth management firm.

"The difference comes in their trading strategies and in the costs of management. High-trading and aggressive dividend funds may have great returns when the markets are excited, but may have the greatest volatility in the eventual return to normality," Mr. Reynolds said.

Most dividend funds "look very much the same on the surface," said Dan Hallett, a mutual fund analyst based in Windsor, Ont. As a result, competition has increased, especially between actively managed funds and increasingly popular exchange traded funds, he said.

"With some new ETF products focusing on dividend-paying equities, actively managed funds face much stiffer competition and more pressure to prove the value of their active management in this narrow segment," he said.

Kevin Cork, president of Calgary's Absolute Group Inc., has four simple criteria for evaluating funds, including the dividend asset class:

What is the management teams' philosophy when it comes to managing money?

Is the team disciplined? Does it stick to the philosophy even when it is out of favour?

How effective is the fund company when it comes to administering client accounts?

How is the performance? What are the fund's returns against its peers and the index? What is the fund's volatility? "I do not look at distributions," said Mr. Cork. "We tend to focus more on the volatility of the fund over its performance since we are not using these funds for their growth."

A survey of advisers found a handful of picks:

Elliott & Page Dividend Fund: The $798-million fund is a dark horse favourite of Michael Morrow, a financial adviser based in Thunder Bay, Ont.

The fund has posted average returns since its inception in August, 2003. But manager Alan Wicks of MFC Global Investment Management (Toronto) has an "extremely impressive record" running the Elliott & Page Monthly High Income Fund, and Mr. Morrow is convinced the dividend fund will follow suit.

"Since this fund return was below average in 2006, you can buy from a manager with an impressive record on a dip," Mr. Morrow said.

Empire Dividend Growth Fund - Class A: A rare segregated fund pick. The asset class has attributes similar to those of a life insurance policy, including a guarantee on all or part of the initial investment. The catch is fees can be steep and eat into returns.

Lorne Marr of Lorne S. Marr Insurance Services Ltd. in Markham, Ont., singles out this $655-million fund managed by Deborah Frame.

The fund has several winning attributes: a capital guarantee, two free resets a year that enable clients to lock in growth, and, perhaps most importantly, a 2.59-per-cent management expense ratio that is surprisingly lower than the fees charged by some much larger dividend equity funds.

iShares Cdn. LargeCap 60 Index: The $9-billion exchange traded fund is a favourite of many advisers. The Barclays Global Investors Canada Ltd. fund has a tiny MER of 0.17 per cent, diversification and unbeatable returns, said portfolio manager Adrian Mastracci. "I advise clients to buy ETFs," said Mr. Mastracci, head of KCM Wealth Management in Vancouver.

"I want low cost diversification, I want quality companies. The low fees mean you take less of a haircut in a bear market, too," he said.

RBC Canadian Dividend Fund: Low fees and a solid long-term track record make this $8.4-billion fund a top pick for many advisers. Managers Shane Jones and John Varao have consistently beat the performance of their peers and trumped the five- and 10-year returns of the S&P/TSX 60 Total Return Index, too.


Top dividend funds

Returns of 10 largest funds by assets under management

Fund Assets under Management ($billion) MER 1-year return 3-year return 5-year return
iShares Cdn. LargeCap 60 Index$9.00 0.17%+15.5%+19.0%+13.7%
RBC Cdn. Dividend 8.41.72+11.7+15.9+14.1
BMO Dividend 5.61.73+11.4+16.1+14
PH&N Dividend Income-A3.51.15+17.2+14.3+12.6
AGF Cdn. Large Cap Div. Classic3.31.83+11.8+17.9+12.2
Investors Cdn. Large Cap Value - A2.82.71+7.8+16.8N/A
CI Signature Dividend 2.21.81+8.8+10.6+8.4
Standard Life Cdn. Div. Growth - A2.01.93+9.5+15.6+12.8
Scotia Cdn. Dividend 1.91.64+11.0+15.9+13.3
Mackenzie Maxxum Dividend1.62.41+12.7+10.6+9,7

Note: Data as of Jan. 31, 2007


© 2007 The Globe and Mail. All rights reserved.

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