Dividend-focused funds are all the rage

If there’s one universal truth about the mutual fund industry, it’s that it has never let an investment fad pass it by.

Thanks to recent tax law changes and chaotic market conditions over the past three years, dividend-paying stocks are back in vogue.

The number of firms in the Standard & Poor’s 500 stock index that had increased or initiated dividends rose to 161 through Aug. 18, up 36.4% from 118 a year earlier, says Howard Silverblatt, a market analyst at New York-based Standard & Poor’s. Through Aug. 18, 11 companies had raised or started to pay dividends, up from nine in all of August 2002.

Fueling the popularity of dividends are recent tax law changes that lowered the personal tax on dividends to 15%, from 38.6%. Fund companies are scrambling to launch funds aimed at taking advantage of the lower tax rate.

“Today’s investors really have a bird-in-the-hand mentality,” says Bill Gillen, national sales director at Boston’s Eaton Vance Corp., which last month launched the Eaton Vance Tax-Managed Dividend Income Fund. “They want to see a dividend because it is more predictable and more measurable.”

Other companies that recently launched, or plan to launch, dividend-focused funds include Charles Schwab & Co. Inc. in San Francisco, Waddell & Reed Financial Inc. in Overland Park, Kan., and Deutsche Asset Management in New York.

Critics contend there is nothing “new” about the current crop of dividend-focused funds.

For years, investors have had access to such funds through so-called equity income funds. Indeed, most equity income funds invest primarily in stocks that pay dividends.

Investors poured $11.4 billion in fresh money into such funds in the first half of the year, up from $10 billion during the same period a year earlier.

In all of 2002, new money going into such funds totaled $14.1 billion, up from $9 billion in 2001, according to Financial Research Corp. in Boston. In 2000 there were nearly $21 billion in outflows.

“There’s not much reason to buy one of the newly launched funds given that funds have been doing this for many years,” says Russel Kinnel, a senior analyst at Morningstar Inc., a fund tracker in Chicago. “Some of these funds that have really good managers and long track records are much more appealing and will deliver more pleasing results.”

For investors looking for extra income, Mr. Kinnel recommends funds such as T. Rowe Equity Income, Gabelli Equity Income and Washington Mutual Investors Fund, which is run by the American Funds.

Proponents of the new breed of funds, however, maintain there are distinct differences. The most obvious is that traditional equity income funds aren’t mandated to invest in companies paying dividends that qualify for the 15% tax rate.

Some equity income funds, for example, may invest in real estate investment trusts or certain foreign companies – both of which pay dividends that don’t qualify for the lower tax rate.

Still, it remains to be seen whether financial advisers will be wooed by the new dividend-focused funds.

“I’m just not out looking for a dividend fund,” says Andrew Tapparo, president of Tapparo Capital Management, a Topsfield, Mass., firm that oversees about $22 million in assets. “For me, it’s all about total return, not just the income return.”

Mr. Tapparo says that the recent influx of new dividend funds bears all the markings of a fad.

Eaton Vance’s Mr. Gillen, however, insists it’s not a fad. “The environment has changed and will be different for an awfully long time.”