The Wall Street Journal-20080112-Dividend Funds- Time for Comeback-- Rates on T-Bills- CDs Could Send Investors Looking Elsewhere
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Dividend Funds: Time for Comeback?; Rates on T-Bills, CDs Could Send Investors Looking Elsewhere
Investors who do their banking at Bank of America Corp. could have locked in a 4.8% annual percentage yield a week ago on a four-month certificate of deposit. Or they could have bought the bank's stock, grabbing hold of its roughly 6.6% annual dividend yield.
With rates on Treasury bills, savings accounts and CDs suddenly low -- and possibly headed lower -- dividend-growth and equity-income mutual funds may come back into vogue.
At the same time, investors may start paying more attention to stocks that can either reliably return capital through quarterly payouts or whose prices have fallen so far that their dividend yield compensates for risk. An added bonus: Dividend payouts are generally taxed at 15% for federal purposes, compared with typically higher individual rates charged on interest income generated by bank accounts and some bonds.
Of course, a T-bill, savings account or CD generally offers an investor capital protection that is lacking in a stock. For starters, share prices can decline -- which has been the case for anything financial these days.
Many investors chasing high dividend yields, as well as mutual funds that focus on this strategy, got burned in recent months as banks and brokers took a beating owing to mounting write-downs of securities linked to risky mortgages. Dividend yield measures how much of a payout an investor receives as a percentage of the share price; it moves inversely to the stock price so when a share falls, its dividend yield rises.
The iShares Dow Jones Select Dividend Index Fund, an exchange-traded fund that tracks higher-yielding stocks, for instance, is down 11% in the past three months and 8% in the past year, trailing the Standard & Poor's 500-stock index for both periods. The S&P index's dividend yield is above 2% for the first time in years.
Bank of America is a case in point. As recently as early October, its stock was trading above $50 a share; last week it was fetching less than $40. Some investors worry that the shares could fall further if mortgage-related write-downs in the fourth quarter top analyst expectations of $4 billion to $6 billion.
The bank's move to acquire Countrywide Financial Corp. ladles a bit more uncertainty onto the situation. In outlining the all-stock, $4 billion deal, Bank of America said it may have to raise capital without elaborating on how it would do so. A spokesman said the bank would give more details when it presents fourth-quarter results Jan. 22.
That said, banks are typically loath to cut dividends and analysts don't expect Bank of America to trim its payout. The same can't be said for every institution. Many analysts expect Citigroup Inc. to cut its dividend. That possibility -- along with the bank's weaker capital position compared with peers such as Bank of America and J.P. Morgan Chase & Co. -- offsets Citigroup's chunky dividend yield of about 7.6%.
Such uncertainty prompted Daniel Genter, president and chief investment officer of RNC Genter, a Los Angeles money manager with about $200 million in assets, to sell stock in Citigroup in recent months. But he thinks dividend strategies are going to recover from their recent slump.
"People are gravitating to yield both from a flight-to-quality standpoint and for a large macro reason, which is that people still need more income," Mr. Genter says. That flight to quality will favor large stocks that pay healthy dividends, while falling bond yields make debt less attractive as a source of income, he adds. The yield on the 10-year Treasury bond, for example, has been trading recently at about 3.85%.
In any hunt for dividend yield, investors need to judiciously weigh the benefits and risks of financial companies. Although dividend and equity-income fund managers have been trimming their holdings of these kinds of stocks they still make up a large portion of portfolios.
"Quality of assets and funding" has to come before yield, says Phil Davidson, a manager of the $6.2 billion American Century Equity Income Fund. A big concern: If there is a recession, financial firms may "have to put up capital to bulk up" and "one way to raise capital is to cut dividends."
Some managers are offsetting the risks inherent in financial firms with picks in other dividend-rich sectors. Mr. Davidson's fund, for instance, recently sold down its stake in struggling insurer MBIA Inc. and is focusing more on drug stocks such as Pfizer Inc. and Bristol- Myers Squibb Co.
While both companies have seen their prices falter, they also have maintained relatively solid cash hoards and are increasing their dividends, yielding about 5%. The same goes for AT&T Inc., which recently boosted its dividend and is yielding about 4%.
"Many banks and financials have very high dividend yields, but the question is whether the yields are sustainable" or if "lower earnings in coming quarters means the banks will be reducing their dividends," says John Carey, a manager on the $1.3 billion Pioneer Equity Income Fund. To offset financial holdings, Mr. Carey is considering energy stocks such as Royal Dutch Shell PLC and Eni SpA in Europe, where dividend payouts can be higher.
But a move out of financials isn't necessarily as easy as it sounds. Traditional dividend favorites such as real-estate investment trusts have taken a dive. At the same time, high-yielding utilities stocks have seen prices run up.
