Hennessy Balanced Going to the ‘Dogs’

The Dow Jones industrial average has just celebrated its 100th anniversary, so perhaps it’s fitting that a mutual fund targeting high-yielding Dow stocks should debut.

The Hennessy Balanced Fund, a tiny portfolio based in Novato, Calif., jumped out of the blocks in March with the aim of buying the 10 stocks among the 30 Dow companies that pay the highest dividend yields.

Hennessy Balanced claims to be the first mutual fund to attempt to capitalize on the “Dow Dogs� investment strategy, so named because high-yielding stocks tend to be those that have been beaten down in price.

Topping the current list of Dow Dogs is Philip Morris, which as of June 1 was paying a 4% dividend.

Other companies in the kennel as of June 1 were Texaco (3.8%), J.P. Morgan and Exxon (3.7% each), Chevron (3.4%), General Motors and DuPont (2.9%), Minnesota Mining & Manufacturing (2.8%), International Paper (2.5%) and General Electric (2.2%). This list will change over time as stock prices and dividend payouts change.

The Dow Dogs investment approach, popularized in the 1989 book “Beating the Dow� ($10, Harper Collins) by Michael B. O’Higgins and John Downes, has been a winner over the years. The approach returned a compounded 17.7% annual gain from 1973 through 1995, according to Downes. That compares with 11.9% annually for the full Dow average, he said.

Hennessy Balanced is not making a pure play on the Dow Dogs strategy, however. In addition to owning the 10 Dow stocks in roughly equal proportions, it also owns one-year Treasury bills, splitting the portfolio 50-50 between stocks and T-bills.

“The Treasuries provide a safety factor,� said Neil Hennessy, the fund’s portfolio manager. “Retired people need growth, but they want safety along with it.�

The fund is open to anyone but appeals mostly to conservative individuals, he said.

The hefty T-bill weighting will tend to keep the fund’s investment returns in the plus column while boosting its yield, currently running about 4.3%. But it will also exert a drag on performance at times when stock prices are marching higher.

The fund ([800] 966-4354, $1,000 minimum) has attracted about $6 million since its debut in late March. It does not levy a front-end sales charge but does impose a fee of up to 0.75% a year to recover marketing costs. Total annual expenses, currently running a stiff 1.9%, will decline to 1.1% when the fund reaches $30 million in assets, Hennessy said, and will continue to drop.

Hennessy Balanced is the first attempt at running a mutual fund by Hennessy Management, an arm of a small brokerage located 30 miles north of San Francisco. But Hennessy said the firm’s lack of experience in the fund business is not a problem given the simplicity of the Dow Dogs approach and the company’s expertise in general money management over the years.

“You’re not investing in [Hennessy Management] so much as you’re investing in a strategy that has worked extremely well over time,� he said.

Investors can pursue a similar strategy on their own, but economical buying of blocks of 100 shares for each of the 10 companies would require a lot more cash than Hennessy Balanced’s $1,000 minimum.

Also, it would be difficult to make incremental investments in each of the 10 stocks on an ongoing basis, as Hennessy Balanced is doing.

It’s worth noting that many brokerages offer “unit investment trusts� that pursue the Dow Dogs approach. These are unmanaged portfolios that hold the same stocks as those identified in the strategy, changing the mix as needed once a year. Unit trusts levy front-end sales charges and thus tend to be a bit more costly than Hennessy Balanced, given its current expenses. But they do pursue a pure Dow Dogs strategy, without splitting their assets among Treasury bills.

Not everybody thinks it’s wise to hold only high-yielding Dow stocks. One critic is Steven Adler, who runs the ASM Fund in Tampa, Fla.

ASM ([800] 445-2763, no load) owns each of the 30 Dow companies, in the same weighting as they are represented in the average. Anyone focusing on a high-dividend strategy would have missed Woolworth, a top-performing Dow stock this year, Adler said. A 10-stock portfolio is also less diversified and thus more volatile, Adler said.

Besides, hefty dividends are not in vogue these days, Adler said. Companies would rather keep the money for other purposes, and investors aren’t eager to receive them because they face higher tax rates on dividends than on capital gains.

“The constellations these days are lined up against paying high dividends,� Adler said.

He pointed out that the Dow Dogs approach has not produced such brilliant relative returns in the 1990s and ‘80s as it did in the ‘70s.

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The Merger Fund, one of the least volatile stock mutual funds around, closed its doors to new investors June 1. The fund’s portfolio managers specialize in merger arbitrage: They attempt to capitalize on any spreads in the stock prices of two companies from the time a merger has been announced to when it is consummated. The no-load fund ([800] 343-8959), based in Valhalla, N.Y., will continue to accept money from existing shareholders.

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Charles Schwab & Co. has introduced a fund it hopes will beat the Standard & Poor’s 500 index by using so-called quantitative stock-picking techniques. The Schwab Analytics Fund will screen larger U.S. stocks for traits it believes will generate good performance, including profit momentum, favorable analyst reports and major shareholders’ trading. The no-commission fund ([800] 2-NOLOAD) will also feature relatively low expenses of about 0.75% yearly.