The performance of traditional dividend-paying bond-like stocks, such as utilities, are sagging as interest rates edge up. Flat earnings won't help, either.
Not even a second quarter sell-off could make bond like stocks attractive in the face of rising interest rates.
Despite a steep decline from mid- to late June, the S&P 500 index managed to gain 3% in the second quarter of 2013. But classic dividend paying stocks like utilities, real estate investment trusts and consumer staples trailed, thanks to a surge in interest rates.
Utilities as a group took the worst lumps, with the S&P Utilities Select Sector Index losing 2.78% for the quarter. REITs, as measured by the Dow Jones U.S. Select REIT Index fell 1.31%. Consumer staples were basically flat according to the S&P Consumer Staples Select Sector Index.
Despite bond like equities getting substantially cheaper, equity income mutual fund managers are not looking at these stocks any more favorably.
“Within the equity markets, be careful about owning bond like equities,” said Don Taylor portfolio manager of $11 billion Franklin Rising Dividends Fund (FRDPX). Instead, focus on companies that have the ability to grow their dividends, he said.
“Dividend growth will withstand a further backup in interest rates,” Mr. Taylor said.
Matthew Fruhan, manager of the $6.7 billion Fidelity Growth and Income Fund (FGRIX), is also steering clear of bond like stocks, which have high dividend payouts and constrained growth prospects, he said.
“They can only grow dividends with earnings,” Mr. Fruhan said. “I'm looking for companies with a growing income stream.”
Mr. Fruhan does see a lot of opportunity for companies outside of the bond like sector to grow dividends. Currently, corporations are paying out about 30% of profits to shareholders via dividends. That's way down from the 40 to 60% they have historically paid out, according to Fidelity Investments.
Overall, dividend payments from companies in the S&P 500 rose 15.5% in the second quarter, according to Standard & Poor's Corp. That marks the tenth-straight quarter in which dividends grew by more than 12%.
One area growing in popularity with dividend hunters is technology.
“Technology companies are beginning to recognize that shareholders want dividends, and that share buybacks don't always work,” said Judy Saryan, portfolio manager of the $935 million Eaton Vance Tax-Managed Global Dividend Income Fund (EADIX). “There is an incentive to provide cash and these companies have a lot of cash on their balance sheets that is just sitting there. They need to do something with it otherwise it's a drag.”
In April, IBM raised its dividends 12% to 95 cents a share while Apple increased its payout 15% to $3.05 a share.
Some advisers, however, aren't ready to give up on owning old-school dividend stocks.
“Dividend-paying stocks are the place that you should still be investing for someone looking long term, for a decade or more,” said Michael Sangirardi, financial planner at Bryant Park Wealth Advisers, a franchise of Ameriprise Financial. “The dividends still give you what you're going to need — potential for growth and hedge against inflation. It's still a very solid investment for someone who's trying to grow their retirement portfolio.”
(Additional reporting by Jason Kephart)
