June 24, 2010

At Morningstar Conference, a Focus on Dividend Investing

Panel of dividend-investing pros suggests avoiding banks, but not energy

At the opening session on day two of the Morningstar Investment Conference in Chicago on Thursday, June 24, three dividend-focused mutual fund managers talked about what they called the great opportunities in dividend investing now, and pooh-poohed worries that higher taxes on dividends would lead companies to cut their payouts.

Hersh Cohen, chief investment officer for Legg Mason's Clearbridge Advisors, argued that a money manager who focuses on a company's dividend "asks simple questions, but gets profound answers." While he warned against investing in certain parts of the financial services sector--"You'd have to take a big leap of faith to invest in banks right now, dividend-wise"--he also argued that building a portfolio with "a package of these great (dividend-paying) companies is a great way to get income." Among those great companies in the financial services sector that came out of the markets and economic crisis "in great shape," Cohen said, are Chubb and Travelers.

Another member of the panel that was moderated by Morningstar's Sonya Morris, Joe Matt of American Funds, expressed some concern over the current payout ratio, noting that even companies that are paying dividends have slowed the growth in those payouts, and that part of his job was to encourage companies to "look at the dividend equally with stock repurchases."

Cohen said that while companies are wondering what will happen with the Obama Administration on raising taxes on dividends--"we assume it will go much higher"--he said that companies "will not stop increasing dividends because of higher taxes; it's not that simple" a decision-making process for many companies that continued to increase their dividends even through the 2008-2009 crisis.

The third member of the panel, Don Kilbride of Wellington Management, portfolio manager of the Vanguard Dividend Growth Fund, agreed that "when dividend policy is set, at the board level, taxes are not part of the equation."

As for where to be and what sectors to avoid when investing with an eye toward dividends, Kilbride said that in the aftermath of the BP oil spill in the Gulf, "the expense of drilling is going higher," but that deep-water oil drilling is still where the reserves are, and in terms of dividends going forward, energy "is still a good place to be."

On another area that traditionally pays good dividends, Cohen said that "we own AT&T and Verizon, but we own them nervously; I worry about the business model--we've decided the dividends are safe for the foreseeable future; but you don't want to bet the ranch on them," putting in an argument for diversification: "That's why you have a diversified portfolio."

Kilbride agreed that in regulated utilities like telecommunications, "the legacy of the regulated business model is enough to support dividends," but he doesn't see growth in telecom company dividends.

The discussion ended with observations about investors who recently are looking for high yield. "Yield chasing can be dangerous," said Kilbride, arguing that "sometimes a high yield is a message from the market that's something wrong" with the company. Cohen agreed, saying "more money has been lost chasing suspect yields."

Read a story about mutual fund disclosures at the Morningstar Conference from the archives of InvestmentAdvisor.com.

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