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Bucking the Trend: Equity-Income Funds

Bucking the Trend: Equity-Income Funds

While actively managed stock funds bled more than $172.3 billion over the last year, one category of actively managed equity funds is bucking the trend.

While actively managed stock funds, both U.S. and international, bled more than $172.3 billion over the last year, one category of actively managed equity funds is bucking the trend: U.S. equity-income funds. According to Morningstar data released Friday, as of May, these dividend-focused funds have raked in $21.7 billion over the last 12 months.

Two funds in particular, the BlackRock Equity Dividend Fund and Vanguard Dividend Growth Fund, account for nearly half of the group’s inflows in the past year.  

Morningstar analyst Kevin McDevitt attributes the inflows to their strong yields relative to bonds. These equity-income funds have a median 12-month yield of 2 percent after expenses, compared to the median U.S. large-blend fund, with a yield of 1 percent after expenses.  

Investors are also likely flocking to these funds out of risk aversion. Investors are not comfortable investing in some of the more volatile, risky areas of the market.

“A lot of times dividend-paying companies tend to be strong, solid blue chip companies, so I think if you’re feeling anxious about the market but still want to have some equity exposure, it can seem like a good way to go,” McDevitt said.

That said, their best days might be coming to an end. If you take into account the flows and performance of these funds, we could see a bubble in dividend-paying funds, McDevitt said. For the last three years, these U.S. dividend-focused funds have taken in $25.8 billion, while actively managed U.S. stock funds have seen $149 billion in outflows. But as is the case with many hot investment ideas, when investors flood into the hot dot, a bubble is created, and the benefits are often exploited out of the market. This is something to be wary of, McDevitt said.

In addition, the valuations of these dividend-paying stocks are not as attractive as they were, say, in 2010, McDevitt said. In 2010, these stocks were cheap relative to small-cap equities, he added.

While these funds stayed in line with the S&P 500 in 2011, returning about 2 percent, these equity-income funds have underperformed so far in 2012. According to Morningstar, the media U.S. equity-income fund was up 3.8 percent year-to-date through June 14, compared to the average large-cap blend fund, up 4.9 percent over that time period. Meanwhile, the S&P 500 returned 6.7 percent through June 14.

But McDevitt doesn’t expect flows to these funds to slow down this year. They could become less appealing in 2013, though, if tax rates on dividends increase.

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