When the previous federal government last November an- nounced its plans to boost the dividend tax credit, which will leave more after-tax dividend income in the hands of taxpayers, the future of many dividend funds took a turn for the better.

Even if the original Liberal proposal isn’t fully implemented, dividend funds should still be on investors’ radar, as most are not as sensitive to energy price movements as broader Canadian equity funds. But there is a wide variance among these funds.

Two established vehicles in this category are the Investors Dividend Fund C, sponsored by Winnipeg-based Investors Group Inc. (including several classes of units, the fund has closer to $11.5 billion in total assets, making it the largest of its kind), and the $1.9-billion TD Dividend Income Fund, sponsored by Toronto-based TD Asset Management Inc.

With a solid four-star ranking from Morningstar Canada, the TD fund’s risk-adjusted performance over the past five years makes it the stronger of the two by a significant margin, Morningstar maintains. (The IG fund gets only two stars.)

The TD fund, a finalist at the recent 2005 Canadian Investment Awards, has been a top-quartile performer 30% of the time, while beating the median fund 68% of the time, Morningstar reports. Over the five years ended Jan. 31, 2006, the TD fund produced a second-quartile, five-year average annual compound return of 12%, returning 20.3% in 2003, 13.4% in 2004 and 16.4% last year. It’s up 2.2% year-to-date.

A third-quartile performer over the same five-year period, the IG fund returned 15.3% in 2003 against a rise in the S&P/TSX 60 index of 25.5%, gaining only 9.6% the following year as the index climbed another 13.8%. And last year, its return was 15.6% vs the index’s return of 26.3%.

Its five-year average annual compound return is a relatively modest 8.3%, which significantly lags the median fund. Year-to-date, the fund is up less than 1%.

Most dividend funds fall into one of two categories: conservative equity funds that emphasize high-yielding common stocks or those that hold a broader selection of equities, preferred shares, income trusts and, on occasion, bonds.

Dom Grestoni, who joined IG in 1976 and held various positions within the company prior to assuming his portfolio-management duties, falls into the former group, following the pattern established by Tighe McManus, who managed the IG fund for 20 years until his retirement in 2003.

Grestoni uses a bottom-up investment selection process, focusing on companies with sustainable profitability and solid histories of high and rising dividend payments. He aims for a 2% minimum yield, with blue-chip equities comprising at least two-thirds of the portfolio. Once the mainstay of the IG fund, preferred stocks now account for only 7% of its assets.

As for bonds, Grestoni believes holding about 20% in fixed-income products will smooth out some of the volatility of an equity-only fund even though the bonds have crimped performance slightly.

Similarly, Doug Warwick — who has been with TD Asset Management and its related companies since 1985, following a brief stint at Bank of Nova Scotia — takes an eclectic approach. He holds bonds from time to time; right now they are about 13% of the portfolio. As well, he has a 14% weighting in income trusts and almost a 7% weighting in preferreds. Neither fund has any significant foreign content.

The TD fund has also been consistently overweighted in the financial services and utilities sectors. Warwick invests in conservative companies that generate healthy earnings and that can consistently grow dividends over time, especially the banks, which makes the TD fund somewhat interest rate-sensitive.

Most of the income trusts he likes have low payout ratios, such as his largest holding, Canadian Oil Sands Income Trust. Otherwise, the balance of the portfolio is fairly concentrated, with 57% in financial services, 21% in energy, 5% in materials, 6% in telecommunications and lesser holdings elsewhere.

With an average portfolio turnover of less than 10% over the past five years and a concentration of about 60 stocks, the IG fund’s portfolio doesn’t change much year-over-year. The TD fund’s portfolio, meanwhile, carries almost 100 stocks, with the top 10 positions representing 46% of assets.

Both fund managers invest primarily in large-cap stocks, enjoying overall dividend yields of 3.3% (TD) and 3.1% (IG).

Understandably, both funds have a large stake in the financial services sector — about 30% of the TD fund is held just in the Big Five Canadian banks, including TD Bank Financial Group.

@page_break@And even though the IG fund does not provide specific holdings data, it also owns shares in every Canadian bank. Typically, neither manager is particularly anxious to hold significant amounts of cash.

The IG fund carries essentially the same price/book measures as its TD counterpart, with both funds mirroring the median fund in the category.

Given their mandates, it is not surprising that these funds present lower risk profiles. The IG fund has a standard deviation of 5.7 over the past five years, while the TD fund’s is 6.5. Both results are lower than for the median Canadian dividend fund.

The funds’ five-year Sharpe ratios — 1.33 for TD and 0.92 for IG — indicate that Warwick’s fund has been the better risk-adjusted performer over time. The gap has closed somewhat, however, over the three-year period.

More important still for a conservative vehicle, the TD fund has been a stronger downmarket performer, better than 85% of its peers, Morningstar reports.

Of the two funds, the TD offering has been the stronger on almost all fronts. And, with costs as a further tiebreaker, it gets the nod as well. The IG fund’s high 2.92% management expense ratio is far above the 2.25% category median and, despite a 60% increase in assets, remains unchanged from four years ago, Morningstar reports.

The TD fund’s MER is a more reasonable 2.09%.

Although there is no denying the TD fund’s success in adverse markets, at this price investors who are looking for exposure to Canadian dividend stocks and who are undeterred by a weighting of almost 50% in financial services may want to consider the newly minted iUnits Dividend Index Fund.

This exchange-traded fund matches the Dow Jones Canada select dividend index of 30 high-yielding stocks, including all the major banks, utilities, pipelines and telecoms.

The yield on this fund is roughly 2.85%. Its MER is just 0.5%. IE