In a perfect world, investing would be simple. It would always be obvious what you were investing in. Unfortunately, though, some investments seem to go out of their way to obscure what they're doing with your money.

One place you'll see misleading names is in the mutual fund industry. With thousands of funds competing for your business, every fund wants to gain an edge over its peers. But in trying to distinguish themselves, some funds go over the line and choose investments that don't fit in with what you'd guess from the fund's name.

Dividend growth, with no dividend?
One such fund is the Fidelity Dividend Growth Fund (FDGFX). At first glance, you might think that the fund was one of many that focuses on stocks that pay well-established dividends that have grown over time and will continue to grow in the future.

But a closer look at the fund's prospectus shows quite a different story. In its words, the fund "normally invests the fund's assets primarily in companies that pay dividends or that it believes have the potential to pay dividends in the future [emphasis added]."

Obviously, that's quite a difference. In particular, it allows in several stocks you wouldn't necessarily expect to find in a fund seeking dividend growth:

  • Topping its holdings are Wells Fargo (NYSE: WFC) and Bank of America (NYSE: BAC), both of which slashed their dividends in response to the financial crisis. Although some have argued that they should start paying higher dividends again, there's no guarantee they'll return to what they paid prior to the crisis.
  • Also on the top 10 list are Cisco Systems (Nasdaq: CSCO) and Google (Nasdaq: GOOG), neither of which has ever paid a dividend. It's true that Cisco CEO John Chambers recently said that he believed the stock would initiate a dividend before his retirement, but he hinged his promise on the health of the overall economy and the company's finances.
  • Look deeper, and you'll that find the fund even owns shares of Berkshire Hathaway (NYSE: BRK-A). Warren Buffett hasn't paid a dividend to shareholders in more than 40 years, arguing that the company can put its capital to better uses. Despite hints that his stance may be changing, it's hard to say with a straight face that it belongs in a dividend fund.

Fund manager Larry Rakers certainly doesn't pull any punches when describing the apparent disconnect. In a recent interview with Kiplinger's Personal Finance, Rakers said, "You open up my prospectus and it says, 'Thou shalt pick stocks that pay a dividend or that Fidelity thinks someday could pay a dividend.' But how does Fidelity pay Larry? They pay Larry on the basis of total shareholder return, so I'm driving my fund to maximize total return." Clearly, he believes that financials and technology stocks are promising candidates, even if they don't necessarily pay much in the way of dividends right now.

In a vacuum, that philosophy might make sense. But it completely ignores why investors buy a fund like Fidelity Dividend Growth and what their expectations are.

What you want isn't what you get
Most investors don't expect a single fund to fulfill all their investment needs. Rather, they choose a set of different funds to build a diversified portfolio. They might choose both large-cap and small-cap funds, domestic and international funds, value- and growth-oriented funds, all to cover their bases.

In such a strategy, what's most important is for managers to do the best they can within their target space. Following this strategy, you don't want your large-cap manager deciding to buy small-caps because they have better return potential, because you already have a small-cap fund that's doing that for you. You don't want your conservative dividend-growth fund buying non-dividend-paying growth stocks, because you've made allowances to buy those stocks elsewhere.

Protect yourself
In order to make sure you're getting what you want, you have two options:

  • Look closely at your fund prospectus to see what limitations there are on the stocks your fund manager can buy. If those limits match up with your expectations, then you should be fine.
  • Use ETFs or index funds that follow mechanical strategies that meet your needs. For instance, for dividend growth, the SPDR Dividend Growth ETF (NYSE: SDY) or the Vanguard Dividend Appreciation ETF (NYSE: VIG) have well-defined rules for which stocks appear in their portfolios.

Nothing's worse than discovering after that fact that your investments aren't what they appear to be. As long as you recognize the danger, though, you can check your funds out before some unexpected situation arises that would otherwise produce a nasty surprise.

Danger means opportunity. Bryan White can tell you how you can profit from pessimism.