Equity-income mutual funds are supposed to do two things: provide a conservative way to invest in the stock market and give investors a bit of regular income, mostly in the form of dividends.
In 1999, many top performers in the category were loaded up with technology stocks and did neither. But as technology stocks crumbled in 2000, the more traditional equity-income funds have rebounded nicely, proving again that they can be anchors in a stormy market.
Through early December, the average equity-income fund was up about 4 percent for the year, according to Lipper Inc., the fund-data provider, compared with a loss of 1.31 percent for the average domestic stock fund. Looking a bit deeper into these funds shows how things have changed in 2000.
In 1999, the best-performing funds in the category had among the lowest yields — meaning dividends and sometimes interest income — including some funds that yielded less than 1 percent of their net asset value.
The worst performers in 1999, by contrast, yielded nearly 3 percent, well above the yield for the Standard & Poor’s 500 stock index, which was 1.2 percent in early December.
In 2000, the tables turned. The year’s top performers in the equity-income category had yields above the average for all equity-income funds, while the bottom dwellers produced little income.
The turnabout has been costly to investors who sold out of equity-income funds, especially if they were chasing the higher returns sported by many technology-heavy funds.
“I think all the people who took their money out of equity-income and conservative funds and plowed it into aggressive growth funds have learned a painful lesson,” said Mike Levine, co-manager of Oppenheimer Capital Income Fund, which was up 10 percent for the year through early December 2000.
For investors looking to buy an equity-income fund, there are a few things to consider.
First, look at funds with good long-term performance and above-average yields. The average fund has a yield of 1.63 percent. You also should look at the fund’s holdings and the volatility of its returns.
Look to see if there are technology companies or non-dividend-paying stocks among the fund’s top holdings and whether the fund has had a lot of fluctuation in its returns.
Such findings are warning signs; these are, after all, supposed to be the most conservative stock funds around.
Data on all these points generally can be found on a fund company’s Web site or on such Web sites as morningstar.com and smartmoney.com.
It is worth checking because, Levine warns, some managers have strayed from what traditionally have been thought of as equity-income holdings.
“I think a lot of people were cheating or playing games,” he said. “It’s unfair to sell your fund as an equity-income fund and to have in your top five holdings tech companies with unreasonable and egregious valuations.
“And certainly if you market yourself as an equity-income fund, you should have some level of income.”
Equity-income funds generally invest in the low-priced “value” stocks, in part because of their conservative nature, but also because dividend yields tend to be highest for stocks whose prices have fallen the most.
After a long stretch of laggard performance, in 2000 many value stocks were outshining high-flying “growth” issues. Add to that the big bets that many equity-income funds made on high-dividend-paying sectors such as utilities and real-estate investment trusts, two of 2000’s best performers, and you have a recipe for a rebound.
American Century Equity-Income, for example, has soared more than 30 percent from its February low and was up 15.4 percent for the year through early December. One reason is that stocks of good companies got very cheap in 2000.
“We took the opportunity to concentrate the portfolio more than usual, making bigger bets on what I call these must-own, high-quality situations,” said Phillip Davidson, the American Century fund’s co-manager.
Davidson’s fund, like many in the category, seeks to keep its overall yield higher than that of the S&P 500. In this case, the goal is to have a yield that is two percentage points higher than the market.
So, even though he will buy stocks with relatively low dividend yields, defined as the per-share dividend divided by the stock price, he can’t go overboard on no-yield technology names. That was tough in 1999, because a lot of funds were under pressure to perform “both internally and externally,” Davidson said.
At the same time, income concerns became less important to many fund investors last year.
Lynn Yturri, manager of the One Group Equity Income Fund with $750 million in assets, said investors figured, why worry about a yield of 2 percent or 3 percent when stocks are soaring.
“If the market is going to grow at 25 percent a year, who needs income?” he said.
The lousy returns of 1999 for income-paying stocks also turned some fund companies away from the space. Last fall, when Lipper reclassified Waddell & Reed Advisor Core Fund as a large-capitalization stock fund from one focusing on income-paying stocks, the fund’s manager had no problems making the switch.
“The role of income has diminished, because that’s where the market has been,” says James Wineland, manager of the fund. Is yield making a comeback? “Not yet,” he says. “At some point in the next decade, as Baby Boomers approach retirement, dividends could make a comeback.” Other than that, he says, “You need a period of three or four years when the market is flat” for yield to look attractive. Wineland’s fund has stocks that pay dividends, but most of those are small, keeping the 12-month yield of the fund at about 1 percent.
One of the largest equity-income funds without a lot of dividend-paying stocks is Janus Equity Income Fund, which sported a handsome return of 38 percent in 1999 but is underperforming this year with its light 12-month yield of 0.54 percent, according to Morningstar. (Lipper, in fact, characterizes the portfolio as a growth fund, not an equity-income fund.) Through Dec. 6, the fund had posted a loss of 6.5 percent for the year. A Janus spokeswoman said the fund invests according to its prospectus, which says that 65 percent of its holdings are to be dividend-paying stocks.
Some managers feel vindicated for sticking to their mandate while others strayed. “We believe in truth in advertising,” said American Century’s Davidson.
