Mutual Funds Clone the Dogs of the Dow

The sidewalks are sizzling. The subways are steamy. The market is wilting. The dog days of summer are once again upon us. Time to see how the dogs of the Dow, and their mutual fund masters, are handling the heat.

For those unfamiliar with the concept, the dogs of the Dow are not members of an index tracking pet stocks but rather an investment strategy that advocates buying the 10 Dow Jones Industrial Average stocks with the highest dividend yields. Adherents to the dogs' philosophy believe these beaten-down stocks -- remember, yield moves inversely to price -- are undervalued and due to rally.

Typically, dog investors readjust their portfolios at the beginning of each calendar year. The daily progress of the dogs can be tracked on Web sites such as DogsoftheDow.com. The 2004 list includes Altria(MO Quote), SBC Communications(SBC Quote), General Motors(GM Quote), J.P. Morgan Chase(JPM Quote), Merck(MRK Quote), DuPont(DD Quote), Citigroup(C Quote), Verizon(VZ Quote), General Electric(GE Quote) and Pfizer(PFE Quote).

The strategy was first popularized by Michael O'Higgins in his book Beating the Dow, published in 1991. O'Higgins showed that over the 17-year period from 1973 to 1989, his dogs strategy averaged a return of 17.9% annually, compared with 11.1% for the 30 stocks in the Dow.

More recently, during the tech bubble of the late 1990s, the value-based dogs remained positive, though they lagged behind the returns of the S&P 500 (SPX Quote), which favored growth stocks. When growth stocks went decidedly out of favor during the ensuing bear market, the dogs behaved magnificently, outperforming the S&P by 15.6 percentage points in 2000, 7 points in 2001 and 13.2 points in 2002.

So far this year, the dogs have been barking up the wrong tree. As of July 29, the year-to-date return for the dogs is a negative 5.9%, not including dividends, compared with a loss of 0.9% for the entire 30-member Dow. The S&P is up just under 3% thus far this year. Still, that's not to say these stocks aren't worth another look.