Many companies cut their dividends amid the credit crunch and recession, struggling to turn a profit and stay afloat. But stronger companies’ dividends have stabilized, and payouts are improving along with the economy. Co-managed by two well-seasoned professionals, this fund follows a unique investment strategy that pays off with high yields.
Meridian Equity Income (MUTF:MEIFX) focuses mainly on US equities that have high dividend yields. The fund is highly diversified, with 60 positions across a variety of industries. Its dividend yield averages 3.58 percent—significantly higher than the S&P 500’s average yield of 2.05 percent.
Over the last 40 to 50 years, the top 20 percent of companies with the highest yields in the S&P 500 beat the index by 300 basis points. Aster cites this outperformance as evidence that a yield-focused strategy works.
Although high yields are the fund’s primary goal, manager Richard Aster Jr. is selective. “Even if the company has the highest dividend yield in its industry, it must have solid financial fundamentals to prove that the firm can maintain and growth their dividends,” says Aster.
Like most funds, Meridian Equity Income recorded negative returns in 2007 and 2008, hobbled by the financial crisis and market meltdown.
“In difficult times, income equities are supposed to give investors support. But they didn’t this time around because their fundamentals got so bad that many had to cut their dividends,” notes Aster.
But 2009 was a better year, though the fund still trailed the market. This year it’s beating the S&P 500 by 450 basis points.
And the fund has outperformed the broader market since its inception in 2005: As of this writing the fund is up 5.23 percent, well ahead of the S&P 500’s 1.15 percent return.
Aster attributes the fund’s solid track record to keeping things simple. Instead of looking at industries, Aster and his partner James O'Connor focus on individual companies. Even if the industry isn’t attractive, the managers will still invest in an individual name if the company is healthy and has a high dividend yield.
The pharmaceutical industry provides a case in point. The new health care legislation has prompted many drug companies to lower their earnings forecasts and many investors to search out replacement stocks. Despite this trend, Aster and O’Connor like Baxter International (NYSE: BAX), a company that offers a solid dividend yield and business lines with attractive growth prospects. The firm’s injectable therapies have the scope to increase sales in emerging markets, while its BioScience unit offers long-term upside.
The publishing industry has also taken its lumps, and ratings agencies such as Standard & Poor’s have come in for substantial criticism, but the managers see strength in McGraw-Hill (NYSE: MHP) and its 3.2 percent yield.
Many companies cut their dividends during the recession, but global construction and mining equipment manufacturer Caterpillar (NYSE: CAT) managed to maintain its quarterly payout. The firm’s business has stabilized in developed markets and should continue to grown in emerging markets. With a seasoned management team and strong growth prospects, Caterpillar remains the fund’s largest holding.
As stock prices fell during the downturn, buying opportunities emerged. For example, health care behemoth Johnson & Johnson (NYSE: JNJ) generates ample cash flow and offers attractive growth potential in international markets. Despite these positives, the stock still sold off with the rest of the market—a compelling buying opportunity for Aster and O’Connor.
The economy is much stronger these days, but yields tend to fall closer to the S&P benchmark as stock prices recover. In these instances, Aster and O’Connor look to book gains and invest in a higher-yielding stock.
One negative for the fund is a possible tax hike on dividends. When tax cuts expire at the end of this year, the tax on dividends could rise from 15 percent to 40 percent. However, the fund’s average yield of 3.575 percent represents a solid payout in periods of high and low taxes.
With Treasuries at these levels, investors are having a hard time finding safe places to grow their money. And although the economy is getting stronger, investors remain cautious because uncertainties in Europe and the US. But equities provide capital appreciation and high dividend returns for its investors.
Aster also manages Meridian Growth (MUTF:MERDX), a fund we profiled last year, and has a track record of success. Quality management always goes a long way.
Disclosure: no positions
Disclosure: no positions