Dow Shuffle a Tough Bone to Chew for Dow Dogs Funds - TheStreet

Dow Shuffle a Tough Bone to Chew for Dow Dogs Funds

The popular investing theory hasn't produced market-beating returns, and the addition of non-dividend-paying stocks won't help matters.
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Tuesday's changes to the

Dow Jones Industrial Average

have left some fund managers speculating that the popular Dogs of the Dow investing strategy is seeing its last days.

"The dogs are certainly yelping," says Dan Kraninger, president of

O'Shaughnessy Capital Management

, which used to offer a Dogs of the Dow mutual fund. "I think dividend investing with the Dow 30 is taking a serious kidney shot today."

The Dogs of the Dow, of course, are the 10 highest-yielding stocks in the 30-stock DJIA. A popular market strategy holds that the highest-yielding stocks as of year-end will give investors a higher return over the next 12 months than the DJIA itself or the

S&P 500


But some managers say the strategy -- which hasn't actually outperformed the S&P 500 or the Dow since 1995 -- will have even less chance of working nowadays because there isn't enough of a dividend anymore to make up for the stocks' relative underperformance.

On Tuesday, editors of

The Wall Street Journal

, who choose the stocks in the index, booted



, which has a current yield of 2.7%;

Goodyear Tire & Rubber

(GT) - Get Report

, 2.7%;

Sears Roebuck

(S) - Get Report

, 3.2%; and

Union Carbide


, 1.5%, from their stodgy benchmark. They brought in non-dividend-paying


(MSFT) - Get Report

, along with


(INTC) - Get Report

, 0.17%;

SBC Communications


, 2.2%; and

Home Depot

(HD) - Get Report

, 0.2%.

Even before Tuesday's moves, the Dogs' dividends have been falling for years. For this year's group, the average yield as of Dec. 31, 1998 was 2.8%. That's down from the 3.35% average of the Dogs at year-end 1996.

"With the Dow ... you only have 11 to 12 stocks, potentially, with any meaningful dividend yield," says Kraninger, whose firm is merging its


Dogs of the Market fund into its

Cornerstone Value


"If other stocks start moving out of the Dow, and you start to put more representative growth companies in it -- which is what the true economy is -- maybe the Dogs of the Dow theory isn't applicable anymore," says Richard Begun, manager of the Dow-based


Orbitex Focus 30 fund.

But aside from the Dogs theory, mutual fund observers say Tuesday's changes to the index's lineup won't be widely felt.

"From the mutual fund industry's perspective, this is pretty much a nonevent," says Matthew Gries, an analyst with Chicago fund-tracker



Morningstar tracks just five funds that invest directly in the Dow components or use the Dogs of the Dow strategy. Their total assets: $326 million. By comparison, more than $253.3 billion is indexed to the S&P 500, according to Morningstar.

Because the four stocks that are leaving the industrial average haven't been stellar performers in recent years -- both Goodyear and Chevron are on 1999's Dogs list and Sears has a good shot at joining them on next year's list -- their removal from the group isn't likely to result in big capital gains for investors when managers cash out of those stocks.

"I don't expect a huge capital gain in my portfolio," says Richard Moroney, co-manager of the



Dow 30 Value fund. "We have enough

losses to offset it."

Unlike funds that track the S&P 500, Dow funds didn't even come into existence until 1998, when

Dow Jones


began licensing its index to be used in connection with mutual funds. That means funds that invest in the Dow components have held them for a relatively short period of time and haven't built up big unrealized gains. Many S&P 500 funds have been holding the same stocks for 20 years and have sizable gains built up in many of them.

Investors in


(DIA) - Get Report

, the

American Stock Exchange

-traded securities that are composed of the 30 Dow components, also aren't likely to face big capital-gains bills. Diamonds now have more than $1 billion in assets.

Selling off the four departing Dow stocks "will actually help the

Diamonds' trust in that it will create some realized losses to carry forward," says Doug Holmes, a principal at

State Street Global Advisors

, which manages the Diamonds portfolios for the Amex.

The real losers of today's change then, might just be the stocks getting kicked out of the index. With decreased demand for their shares, they could become the short-sale targets of the fall.

"Goodyear and Chevron were both Dogs of the Dow as of Dec. 31,

1998," says Strong's Moroney. "They're both stocks that don't have a lot of near-term appeal otherwise. How much are those names going to get hit when people really start moving out of those? I don't have an answer to that, but it's going to be interesting. I tend to think there's going to be more pressure on those stocks."

For more discussion of the new Dow, don't miss our TV show this weekend on

Fox News Channel

. This week's guest is Charles Carlson, co-manager of the Strong Dow 30 Value fund. The

show is scheduled to air at 10 a.m. and 6 p.m. ET Saturdays, and at 10 a.m. ET Sundays.