Dogs of Dow Lead the Pack

These highest-dividend-yield Dow stocks are easy to find and, this year, worth hanging on to.
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Editor's note: This review of the Dogs of the Dow and related mutual funds is part of a new partnership with Nightly Business Report, which provided additional insight during its broadcast (at about the 18 minute mark).

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


, 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 such websites as

. This year's list includes


(T) - Get Report



(VZ) - Get Report



(DD) - Get Report






(MRK) - Get Report



(CVX) - Get Report



(MCD) - Get Report



(PFE) - Get Report


Home Depot

(HD) - Get Report



(BA) - Get Report


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

, 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 from 2000 through 2002.

The dogs had a mixed record during the housing bubble's inflation from 2003 to 2007, beating the greater indices in some years and losing in others. The popping of the bubble in 2008, however, caused the dogs to lose 38.8% for the year compared with a 31.9% loss for the Dow, primarily due to the inclusion of poorly performing bank stocks


(C) - Get Report


JPMorgan Chase

(JPM) - Get Report

-- not to mention

General Motors

, which ultimately filed for bankruptcy. The dogs bounced back in 2009, returning a respectable 16.9%, although it was not enough to beat the Dow or S&P, which both boasted yearly gains of more than 20%.

So far this year, the dogs are once again leading the pack. As of July 9, the year-to-date return for the dogs is negative 1.3%, not including dividends, compared with a loss of 3.5% for the entire 30-member Dow. The average yield on the dogs is a hefty 4.5%, compared with 2.9% for the whole Dow.

Mutual Fund Dog Owners

Investing in the dogs is a relatively straightforward proposition for retail investors. Those who prefer to invest in the dogs through a mutual fund, however, can choose from a pair of funds, though neither invests its assets entirely in the 10 dog stocks.

The $11.5 million

Hennessy Balanced

(HBFBX) - Get Report

fund puts 50% of its assets in the dogs and the other half in one-year Treasury bills, while the $50 million

Hennessy Total Return

(HDOGX) - Get Report

fund has a 75%-to-25% dogs-to-T-bills ratio. Hennessy's Balanced fund charges an expense ratio of 1.73%, while the Total Return's cost is 1.27% a year. Neither of the pair carries a sales load. Both are leading the indices year-to-date.

Video: Boutique Banks Beating Street's Top Dogs >>

Of course, the simplicity of the dogs strategy makes you wonder whether it's necessary to surrender any of that dividend yield or potential capital appreciation to a mutual fund manager. After all, there are just 10 stocks involved, and there is little if any research necessary; the members of the group can easily be found on the Internet.

One explanation as to why investors might choose dog funds over buying and rolling over the individual stocks on their own is that they might lack the discipline to switch the member stocks on an annual basis. And as fund manager Neil Hennessy explains, "having a discipline is better than having no discipline at all."

"This strategy is not a get-rich-quick scheme," Hennessy says. "It's designed to provide a consistent return with low volatility. It's a very disciplined approach to investing."

And if they do well in these dog days of summer, these dogs just might become a shareholder's best friend.

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Before joining, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.