Equity income funds offer low volatility and long-term growth--most of the time


Like most mutual-fund investors, you may be counting on equity funds primarily for capital appreciation and on bond or money-market funds for income. A large and growing number of investors, however, have been attracted to a group of equity funds that have income as their principal objective and appreciation as their secondary goal.

They're known as equity income funds, and you may find them worth looking at because of their twofold appeal:

* Their income distributions should grow over time with thdividends they get from the corporations whose stocks they own.

* The types of high-dividend stocks they invest in heavily, such as utilities, tend to be less volatile than growth stocks. Equity income funds may not soar as high as growth funds when the stock market is up, but they also are not expected to plunge as much when the market is down.

Or at least that's the theory. Like many investment theories, it doesn't work all of the time. In 1987, equity income funds averaged a small negative total return (that is, the sum of dividends and price change) even though the market averages were up slightly.

In 1990, according to Lipper Analytical Services, the group had an average total return of negative 6.29 percent, again a poor showing compared with the Standard & Poor's 500 Index, which was off 3.10 percent.

Although they've bounced back more than 18 percent since the market's turning point in October, you might wonder whether equity income funds can really be relied on for protection against volatility as well as for high dividends.

It's a good question. The answer: It depends a lot on the fund.

The 68 that Lipper classifies as equity income funds differ, not only in the skills of their portfolio managers, costs to investors and size, but also in their income and growth objectives.

Some shoot for high income, others for income that's not much higher than the yield on the S&P;

500. As a result, they vary in the portions of their portfolios that are dedicated to common stocks, the mixes of their stock holdings, and their allocation of money to bonds and other assets.

Among the 10 largest only the Delaware Group's Decatur I and Vanguard Equity Income have more than 90 percent of their assets in common stocks, according to CDA Investment Technologies.

Evergreen Total Return, United Income, Fidelity Equity-Income, T. Rowe Price Equity Income and Financial Industrial Income are between 70 percent and 85 percent, and Income Fund of America, Fidelity Puritan, and Oppenheimer Equity Income are between 40 percent and 55 percent.

Weakness in high-yield cyclical stocks had a profound impact on stock portfolios in 1990, but that was to be expected as the nation's eight-year economic expansion ran out of steam. What really threw funds off course was the plunge in the stocks of banks and other financial services resulting from the drop in real estate values.

Funds that were heavily invested in those stocks took a beating. Those that stayed with them, however, have benefited from their recovery.

Under the circumstances, it's understandable that the Delaware and Vanguard funds should have been off as much as 12 percent last year -- and up more than 20 percent in the current bull market.

Even a 14 percent common stock position didn't spare Lindner Dividend Fund. Primarily invested in preferred stocks to provide a yield of about 9 percent, the fund had a large stake in Bank of New England preferred that had to be written off, resulting in a total return of negative 6.51 percent last year.

Not all equity income funds disappointed their shareholders last year, though. Financial Industrial Income was one of 10 with positive, though small, total returns.

Portfolio manager John Kaweske attributes his performance to a large dose of shares in the health-care industry and to the fact that his fund held no back stocks until November.

Of course, it's longer-run performance that matters most, and some of the funds have done well. In fact, two, Flag Investors Telephone Income and United Income, beat the S&P; 500 over the last five years with total returns of 15.92 percent and 13.61 percent, respectively, while the Financial Fund came within a whisker of outperforming S&P.;

With the economy weak, General Motors and other companies cutting dividends and stock averages close to all-time highs, is this a good time to begin investing in a well-run equity income fund?

Several managers say they are still finding stocks that represent good value -- including some whose dividends have been cut.

"You have to round up the usual suspects," said Roger D. Newell, Vanguard Equity Income's portfolio manager. "If I didn't buy stocks that had problems, I wouldn't have a portfolio."

If an equity income fund catches your eye, be sure to consider not only how much income you'd like but also whether its long-run performance record indicates you're likely to be adequately rewarded for the volatility that you may experience over the years.

Copyright © 2019, The Baltimore Sun, a Baltimore Sun Media Group publication | Place an Ad