With a lot of equity dividend yields now surpassing bond yields, the case for dividends might seem like a no-brainer. And while portfolio manager Mike Foss believes that good times lie ahead for dividend investors, he warns that clients still need to be careful not to fall into the trap of chasing the highest yields.
“You can get into trouble just stretching for the most yields,” said Mr. Foss, manager of the Brown Advisory Equity Income Fund Ticker:(BADAX).
“Our objective is to have a balanced total return from stocks, with dividends representing a significant portion of that,” he said. “We want to be a total-return equity vehicle, but we want to balance current income and current yield with high-quality companies.”
Mr. Foss manages $400 million in the strategy, including $100 million in the fund, at Brown Advisory, a $29 billion asset management firm. The portfolio is relatively concentrated, with about 40 stocks.
“We have a hard and fast rule that every investment must have a dividend yield that is at or greater than that of the S&P 500,” he said.
The fund's current yield is 3.6%, which compares with 2% for the index. The fund is up 2.1% from the start of the year, which compares with a 1.9% gain for the world stock fund category, as tracked by Morningstar Inc.
Another thing that makes this strategy unique is that it will move up the capital structure to invest in preferred stocks, convertible preferred stocks and corporate bonds if that's where the opportunities are.
The fund, which can invest up to 20% of the portfolio in non-common stock, currently does not own any corporate bonds but does have a 5% weighting in preferred stocks.
The bottom-up stock-picking strategy does not consider companies with market capitalizations of less than $1 billion, which Mr. Foss said generally leaves him with a potential universe of about 500 dividend-paying stocks.
“Some companies get knocked out because the valuation is too high or the quality is too low,” he said.
The fund's largest position, at 4% of the portfolio, is Kinder Morgan Inc., the nation's third-largest owner and operator of energy storage assets. “This is a company that pays out a big share of income in the form of dividends, and the dividends are growing more than 10% annually,” Mr. Foss said. “And the company gets paid based on volume, not on the price of energy.”
Kinder Morgan's stock, which is yielding 3.9%, has gained 2.7% from the start of the year. That compares with a 0.2% decline by the oil and gas midstream category, as tracked by Morningstar.
The S&P 500 is up 5.7% from the start of the year.
Mr. Foss believes that historical patterns are on his side when it comes to dividend investing. “Right now, the dividend payout ratio of the S&P is 29%, and you have to go back to the early 1900s to find ratios that low,” he said, citing a 50-year average payout ratio for the index of 40%.
“Companies have begun to realize they are getting rewarded for paying a dividend,” Mr. Foss said. “Cash is building on balance sheets, there are low debt levels and less stock buybacks. We're starting to see the awakening of a dividend renaissance.”
Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit
InvestmentNews.com/pmperspectives
