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As the calendar turns to 2011, it is time again for investors to start snapping up the 10 highest-yielding components of the Dow Jones Industrial Average ($INDU).
The strategy, known as "Dogs of the Dow," says to buy the 10 Dow components with the highest yields with hopes of getting more dividend income and seeing the past year's laggards outperform.
Outside of increased dividends, yields rise when stock prices fall and so the Dogs strategy aims to capitalize on that dynamic.
It hasn't always worked out that way; investors in the strategy would have gotten a smaller return over the past decade than they would have gotten by investing in all 30 of the Dow components over that period.
Yet the Dogs concept has a significant following that never seems to abate, due in part to its strength during certain periods. It outperformed during the bear market of 2000 to 2002, and it beat the broader market for 2010. The Dogs stocks climbed 15.5% this past year, excluding dividend income, surpassing the Dow's 11% increase.
Including dividend income, the Dogs had a total return of nearly 21% this past year, compared with a 14% total return for the entire Dow, according to Bespoke Investment Group. Last year was the first since 2006 that the total return of the Dogs has surpassed that of the Dow.
This past year's outperformance is making the strategy even more attractive at a time when dividend stocks already are in vogue thanks to continuing uncertainty over the economy and low yields in the Treasury market. The fact that the Bush-era tax cuts have been extended, keeping the dividend-tax rate lower for two more years, only adds to the allure of dividends.
"It is intuitively appealing," said Nicholas Colas, the chief market strategist at ConvergEx. "Buying dividend stocks, especially now, makes a lot of sense given where rates are" in the Treasury market, he said.
While many individuals who prefer the simplicity of buy-and-hold investing like to use the strategy, some fund managers including Frank Ingarra Jr., co-portfolio manager at Hennessy Funds, also employ it in the portfolios they run for clients. The company started the two funds based on the Dogs of the Dow in the 1990s after accurately predicting its appeal "for a type of investor that wants stock market exposure but doesn't want as much volatility," Ingarra said.
The company's Hennessy Balanced (HBFBX) fund, with $12.5 million under management, invests 50% of its assets in Dogs stocks, while the other 50% is in Treasurys with a maturity of less than a year. The fund's performance was hurt by low-yielding Treasury bills, and the fund's gain of 8.2% for the past year lagged behind the broader market.
The Hennessy Total Return (HDOGX) fund, meanwhile, has a 75% allocation to the Dogs. The higher Dogs allocation worked to its benefit this past year, as the fund, with nearly $66 million under management, climbed 14%.
