Equity-income fund should have deeds to justify the name


Your Funds

October 30, 2007|By CHARLES JAFFE

File this under: "Everything old is new again."

Eaton Vance Corp. released a survey of financial advisers this week that showed that a majority "now view equity income as a distinct asset class."

If you have been a fund investor for awhile, you may be scratching your head, because there have been "equity-income" funds and "growth-and-income funds" for years - possibly even in your own portfolio - and you probably thought they already were an asset class.

In fact, Lipper Inc. has a category for equity-income funds, and has had it as a separate asset class for years.

That said, the Eaton Vance study reflects current investment interests, not history. The basic finding was that financial advisers want to use stocks for dual purposes, providing both income from dividends and growth from capital appreciation, and that they want stock-focused funds built to be income-producing supplements to bonds and other income investments.

"That has not been a dominant theme for years, because the 1990s were the decade of the lost dividends," says Duncan W. Richardson, chief equity investment officer at Eaton Vance. "People were mostly thinking about the market as a capital appreciation vehicle, and that got extreme in the '90s, when dividend yields were so low and growth so high."

During the bull market - with dividend yields on the Standard & Poor's 500 falling to historic lows - most funds of this genre were really "growth-but-no-income funds." They may have had a directive to secure dividend income, but most didn't follow it, because focusing on income meant buying slower-growth stocks, sinking a fund to the bottom of the asset class.

During this time, most industry participants divided the world up into tightly focused asset classes. Equity-income issues basically became "large-cap value" funds, because the stocks they held tended to be from under-priced big companies.

"Growth-and-income and growth funds were doing the same thing," says Jeff Tjornehoj, senior research analyst at Lipper. "The better [equity-income] funds used some convertible securities and other strategies to keep income up, but most didn't, because that's not where the money was."

Fast forward to today. Dividend yields are up, but not wildly. Interest rates, however, are low. And tax-law changes reduced the burden on dividend payments.

Thus, heightened interest in stocks that truly live up to the growth-and-income label.

Says Richardson: "People traditionally had bond ladders going out years and years, but that ladder is laying on its side, because you aren't getting much extra income for going out a few years. As a result, people are taking some rungs out of bond ladders and moving that money into income-producing equities. ... You are diversifying away from interest-rate risk and credit risk by looking for income in the equity market."

"It could be a real sea change in the way people think about how they are getting their income."

It could be, except that investors still are largely lost on where to turn for a true equity-income fund.

While market conditions have changed, funds have not necessarily returned to the objective shown in their prospectus. Plenty of funds use the magic words in their names, but not in their deeds.

Fidelity Equity-Income (FEQIX), for example, has a yield of just over 1.5 percent. That's a bit more than double the payout from its sister, Fidelity Large-Cap Value, which occupies the same large-cap asset space, but you'd have to bump it by half to put the payout where it would be attractive to a true equity-income investor.

"If income is important, you need enough to offset expenses and 12b-1 fees on the fund," says Christine Benz, director of mutual fund research at Morningstar Inc., which does not list equity-income funds as a separate asset class.

"You want to be focused on total return - because managers can get into trouble when they go chasing yield - but you'd like the yield to be at 2.25 percent or higher. ... You can look into what the fund holds to see if the manager is using convertibles and other strategies to generate more income."

One other option, for investors seeking income-producing stocks, is to go the route of exchange-traded or closed-end funds, where there is a wide range of equity-income options, many focusing on various flavors of the "dividend achievers" strategy.

"The big point is that advisers - and their clients - want to use stocks to produce income," says Richardson. "Maybe some growth-and-income and equity-income funds were started with this in mind, but they got away from it, so if someone wants to buy equity-income as an asset class, they need to make sure they're getting a fund that will actually do the job."


Charles Jaffe is senior columnist for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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