These Hybrid Funds Put The Accent On Yield

As interest rates continue their downward course, stocks with high dividends gain renewed appeal. For those leery of betting on individual stocks, equity-income mutual funds are a good alternative.

In their quest for both current income and capital appreciation, the funds mix bonds with stocks that have yields above the S&P 500 average. The strategy pays off: Most funds have yields well above the S&P 500 average, now at 3.2%. And over 10 years, the fund group returned almost 15%.

PURIST. These hybrids won't gain as much as pure equity funds in a rising stock market, but their focus on big blue chips mutes their fall in a correction. And while locking in long-term bond yields may seem prudent today, "if interest rates go up 1%, long-term bond-fund prices can go down as much as 8% to 10%," says Kurt Brouwer, president of Brouwer & Janachowski, a San Francisco-based investment advisory firm.

Vanguard's no-load Equity Income fund takes a purist approach. Income-producing stocks make up almost 100% of the fund's holdings. Portfolio manager Roger Newell sifts through 300 companies that have at least $1 billion in assets, a long record of paying dividends, and stocks with above-market yields. The two largest holdings: IBM and Pacific Corp. The fund had a total return of 12.3% over three years. Its current yield is 6.39%.

A consistently strong performer with a more flexible approach is Invesco's Financial Industrial Income fund. The no-load fund invests about a third of its $1.1 billion in bonds and cash. Fund manager John Kaweske says that defensive strategy lets him be aggressive in the rest of the fund, which focuses on health care and financial stocks. The fund's current yield is 3.11%.

Another time-honored no-load fund is Lindner Dividend, which falls into the category only if you count preferred stock. Portfolio manager Eric Ryback's strategy of buying convertible preferred stocks led to a recent 9% increase in the fund's dividend, to 48~. A quarter of the fund's $202 million in assets is in junk bonds, but Ryback says he has had only one default and that he holds the bonds to maturity. A few of his preferred stock picks: Sea Containers, Cyprus Minerals, and KeyCorp.

The minimum investment in a fund is usually around $2,000. Many funds are free of sales charges, but some carry loads of as much as 8.5%.

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