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Is It Too Late to Jump on the Dividend Bandwagon?

Fund managers say dividend-paying stocks became a "crowded trade" in 2011, but they still have long-term appeal.

Christopher Davis, 02/24/2012

By the end of the 1990s, dividends were passe. But after the turbulence of the 2008 financial crisis and its still-unfolding aftermath, dividend-paying stocks reappeared on investors' radar screens. Also, rock-bottom bond yields have pushed many income-oriented investors into stocks.

In aggregate, equity funds suffered net redemptions in 2011, but investors didn't shun those focused on dividends, which enjoyed roughly $3 billion in inflows. Dividend-oriented exchange-traded funds took in a much bigger $14.3 billion haul. Predictably, fund firms launched new offerings to take advantage of the trend, and some already-existing funds became more income-oriented.

Fund companies launched 16 dividend-focused funds in 2011, and already-established funds increasingly favored income-generating stocks. Legg Mason ClearBridge Large Cap Growth SBLGX said generating high income would be its primary objective. Fidelity Equity-Income II, which never fully embraced its income mandate, increased its exposure to dividend payers under new management and changed its name to Fidelity Equity Dividend Income FEQTX to drive the point home.

The Dividend Buzz
Morningstar fund analysts also have heard a wide range of managers, including some that heretofore haven't focused much on income, talk more about dividends recently.

Several of those managers have said the rush into dividend payers has made those stocks more expensive, as their shrunken yields reflect. Dividend stalwart Philip Morris International PM, for example, rose 35% in 2011, slimming its yield to 3.6%, down from 4.2% a year earlier.

AllianceBernstein AB chief market strategist Vadim Zlotnikov referred to the move into dividend payers as a "crowded trade" but said it's too early to bail on them. He favors non-U.S. firms, however, on valuation grounds.

The Last Yield Standing
Higher valuations may limit dividend payers' upside, but there's reason to think they still have room to run. First, bond yields are likely to remain low until at least 2014 (if the Fed gets its way), so income-producing stocks will remain one of the only places to find meaningful yield.

"In fact, we see interest rates as likely to remain low for some time amid an extended period of challenging economic growth, what PIMCO has characterized as the New Normal," said Cliff Remily, manager of PIMCO EqS Dividend PQDAX. "Many global companies are paying dividends well above the current yield on 10-year Treasuries (as of Nov. 30, 2011), and they also provide opportunities for rising income as corporate earnings tend to grow over time."

Christopher Davis is a senior fund analyst with Morningstar and editor of Morningstar's Fidelity Fund Family Report, a monthly newsletter that offers independent, no-holds-barred guidance on the pros and cons of this dominant fund family. He welcomes e-mail but cannot give investment advice. Click here for a free issue of the Fidelity Fund Family Report.

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