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Top Dividend Funds Trounce S&P 500

NEW YORK (TheStreet) -- By some measures, the credit crisis led to the worst period ever for stock dividends.

In 2008 and last year, a record number of companies cut or eliminated dividends, according to Standard & Poor's. As a result, investors dumped shares of longtime dividend payers such as General Electric (GE) and Pfizer (PFE).

Despite the upheaval, some dividend funds have excelled. Investing exclusively in dividend stocks, Frost Dividend Value (FADVX) returned 7.2% annually during the past five years, surpassing 99% of its large-value peers and outpacing the S&P 500 by 6 percentage points, according to Morningstar. Other funds that finished in the top 10% of the category include BlackRock Equity Dividend (MDDVX), Columbia Dividend Income (LBSAX) and RiverSource Dividend Opportunity (INUTX).

How did the funds succeed at a time when dividend stocks were collapsing? Instead of just buying the highest-yielding stocks, the winning managers focused on rock-solid companies that had the potential to increase dividends. The approach led the funds to steer clear from troubled financials and other shaky stocks during the market downturn.

The dividend strategy has long been supported by academic research. Studies have shown that while dividend stocks outperform non-dividend payers over long periods, not all dividend stocks generate similar returns. In a 2006 study by Credit Suisse, researchers divided stocks into 10 groups based on dividend yields. Stocks in the 10th decile -- the highest-yielding group -- returned more than those in the 1st decile, which paid little or no dividends. But stocks in the 8th decile recorded the greatest total returns.

The relatively weak performance of the top decile stocks is no accident, says Dick Dahlberg, manager of Columbia Dividend Income. When stock prices fall, dividend yields rise. So many high-dividend companies are battered businesses. Companies in the top 12% of the dividend payers underperformed the market, and many high-yielding stocks eventually cut their dividends. "You get the best long-term performance from stocks that have growing dividends and yield only a bit more than the market average," Dahlberg says.

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