Use this screen to find income-generating stock funds for both taxable and nontaxable accounts.
Many investors seek the steady income provided by dividend-paying stocks, but companies from across the market-cap spectrum have been cutting dividends during 2008's nerve-jangling market swoon. True, high-yielding stocks haven't been any less volatile than the market as a whole in the past couple of years. Still, for those with long-term investment horizons, dividend-focused funds offer a great way to reap the rewards of income-generating stocks while minimizing the risk that a few companies will affect a client's entire portfolio.
Morningstar Advisor Workstation and Principia are helpful tools for sifting through the universe of stock funds to find higher-yielding portfolios. To set up this screen, we started by searching for domestic stock funds run by skilled stock-pickers. We screened for funds with top-third category rankings over the trailing 10-year period, making sure that the current management was responsible for that record.
Special Criteria = Distinct Portfolios Only
Morningstar Category = Domestic Stock
% Rank Cat 10 Yr <= 33
Manager Tenure (Longest) >= 10
Now, we need to narrow the field to stock funds with high yields. We'll use the prospective dividend yield percentage, which is the asset-weighted average of the prospective dividend yields of all the domestic stocks in the fund's portfolio as of the date of the most recent portfolio. This measure incorporates each stock's prospective dividend yield, which is calculated by dividing estimated annual regular dividends per share for the current fiscal year by the company's month-end stock price as of the portfolio date. Morningstar weights each portfolio holding by the percentage of domestic equity assets it represents so that larger positions have proportionately greater influence on the fund's dividend yield. Here, we set the screen for funds with prospective dividend yields greater than 2%. We wouldn't expect this criterion to give us only dividend-focused strategies, but it should help point us in the right direction.
Prospective Dividend Yield > 2.0
And because dividend-paying stocks tend to lead to greater taxable gains, investors using taxable accounts should consider funds with better aftertax records. One way to do this is to look for low tax-cost ratios. This ratio reflects the percentage-point reduction in an annualized return that resulted from income taxes. Here, we'll look for funds with tax cost ratios that fall under 1.25%
Tax Cost Ratio <= 1.25
Lastly, we required that the funds be open to new investments with expense ratios under 1.5% annually.
Purchase Constraints not= Closed-New Investment
Audited Expense Ratio < 1.5
Here are some of the funds pulled by this screen that Morningstar analysts recommend.
Franklin Rising Dividends
Pioneer Equity Income
Sentinel Common Stock
One of the main things that stands out about this fund is the consistency of its performance, an attribute that has become especially appealing lately. Its returns beat the large-blend category in five out of six years from 2002 through 2007, a span that included both bear and bull markets. In 2008 the fund has suffered ugly losses along with just about everybody else, but as of January 2009, it still ranked in the large-blend category's top quartile for the year to date.
This appealing consistency is a result of manager Dan Manion's low-key strategy, which is designed to stay ahead of the market without taking too many risks. Manion relies primarily on good old-fashioned stock-picking, though he does make modest sector bets and take macroeconomic factors into account. Lately he has been putting a bit more money into predictable consumer-oriented stocks in response to the economic slowdown.
As large as that loss is, the context is important. The fund held up a bit better than the S&P 500 over the same period and beat nearly two thirds of its rivals in the large-value category. More important, the fund had built up an impressive history before this downturn. Helping the fund in this downturn was the managers' long-term avoidance of the riskiest, deep-value type of company, which kept them from betting heavily on the big investment or retail banks even when the stocks looked like they might have become tremendous bargains. (They did own Bank of America
A diverse array of picks have caused this fund considerable pain as stocks across the globe sank in 2008. Intel
Some of its financial stocks have also plummeted, including UBS UBS (which the fund sold early this year) and Allstate ALL. Thus, this fund plunged 41% for 2008, which is almost 4 percentage points more than the large-blend norm and almost 5 percentage points more than the S&P 500 Index.
Such a loss really hurts--and it will take some time to overcome it--but there are grounds for optimism here. Bill Fries, Ed Maran, and Connor Browne are seasoned, and they're supported by a sizable and strong team. The managers let sector weights fall where they may, look outside the mainstream, and run a compact portfolio, so the fund tends to stand out and its individual holdings really matter. And funds need to stick their necks out if they want to post outstanding results.
Karin Anderson is a mutual fund analyst with Morningstar.