As the Fool's resident dividend seeker, I receive quite a bit of email regarding these powerful little payouts. Most recently, the question on many of your minds seemed to be dividend-oriented mutual funds. While there may be funds out there that truly do have a dividend focus, in the case of many of today's funds you should be aware that you aren't likely to receive quite as much dividend love as you'd like.
Ever since the latest round of tax cuts, folks have been heralding the return of the dividend -- even though I wasn't aware it had left. Amid the sounding trumpets, the names of two "dividend growth" funds have been tossed around quite a bit as being good options for "playing" its return. Because of that, and because you've specifically asked about them, let's take a closer look and see whether these two funds pass muster for income investors.
The playing field
The first of this twosome to the dividend punch was T. Rowe Price, which launched its T. Rowe Price Dividend Growth Fund (FUND:PRDGX) in Dec. 1992. According to Morningstar, the fund has returned an annualized 10.68% over the past 10 years, which has it losing to the S&P 500 by about 1% per year. The no-load fund charges an expense ratio of 0.83%, which is fairly reasonable for an actively managed mutual fund but about nine times higher than that of an exchange-traded fund (ETF) that tracks the S&P 500.
Fidelity followed T. Rowe's move with its own Fidelity Dividend Growth Fund (FUND:FDGFX) in April 1993. With a 10-year annualized return of more than 15%, this fund has actually outperformed the S&P 500 by more than 3.3% annually -- an admirable achievement. It does have a slightly higher 1.05% expense ratio, but once again, this is largely justifiable for an actively managed fund with such a high degree of outperformance.
But then there's that dividend thing...
The real story for most investors who are interested in these funds, however, is probably related to that little term "dividend" that's embedded in their titles. If that's your interest, you should probably do your shopping elsewhere, as the titles of these funds are the only places that dividends appear to be etched.
You see, the devil is in the details, and these funds have some interesting ones. For instance, T. Rowe says that its fund will invest at least 65% of its assets in dividend-paying companies. Wow, how novel that almost two-thirds of the assets in a dividend fund will be invested in dividend payers. Better still, you know what that hard-core dividend focus is going to get you in terms of yield right now? Try a steaming-hot 0.99%. That's well below the 1.51% yield you would earn on a Spider (AMEX:SPY) -- an ETF that tracks the S&P 500 and boasts a 0.12% expense ratio.
The Fidelity fund has what -- at first glance -- appears to be a more compelling 80% focus on its target investment group, until you find out that they loosen their definition to "common stocks that [they believe] have the potential to pay dividends in the future." Oh, boy. We'll be paying an awful lot of light bills with these freshly minted potential dividends, will we? Swell. This focus probably explains why the Fidelity fund has a downright puny yield of 0.79%, or nearly half that of the S&P 500.
Another thing you should know about this offering is that manager Charles Magnum often prefers to concentrate assets in just a few holdings or sectors. That can make the fund rather top-heavy at times, increasing volatility. For instance, the fund currently has nearly a quarter of its assets in its top four holdings: Cardinal Health (NYSE:CAH), American International Group (NYSE:AIG), Microsoft (NASDAQ:MSFT), and Clear Channel Communications (NYSE:CCU).
It also has more than 25% of assets in financials and more than 20% in the health-care sector. Again, to be fair, Magnum has proven quite adept at managing this fund, and his often-contrarian or value-oriented approach has trounced the S&P 500. Still, you should understand that his penchant for these types of value plays can add risk, particularly when coupled with the high concentration of the fund. In that environment, it doesn't take a very big miss to result in noticeable damage.
The Foolish Bottom Line
Now, I'm really not trying to take anything away from these mutual funds or their managers in terms of performance or their general appropriateness for your portfolio. What I am taking issue with is their ability to accurately title their funds.
Clearly, dividends are simply part of a value-oriented strategy here and are no more a focus for these funds than they are for any other growth fund or even the S&P 500. Frankly, I find it humorous that any fund with the word "dividend" in its title would sport a yield that's so inferior to that of the S&P. Big focus on dividends, huh?
When you boil down the names, the strategies, and the yields, you really just end up with some fairly average growth funds. Given that, true seekers of dividends should take a pass on these guys, as there are better opportunities out there for income investors. The iShares Dow Jones Select Dividend Index (NYSE:DVY) offers a more meaningful 3.32% yield, a reasonable 0.40% expense ratio, and a pretty good strategy of its own.
Mathew Emmert is afflicted with dividend love but receives his therapy by serving as the editor and lead analyst for Motley Fool Income Investor . He owns shares of Microsoft. The Fool has a disclosure policy.
