Fund companies are slapping the words “income” or “dividend” on to their offerings wherever they can nowadays. The emphasis on income reflects a change in investor psychology since the late 1990s, when demand was huge for stocks in fast-growing companies that were eager to retain earnings and use the cash to expand their business.

Now, regular dividends are viewed as a sign of financial health and companies that pay them are usually larger, with more stable balance sheets and less risk.

The “dividend fund” category is a confusing one, however. Some funds aim for high yield and income; others seek growth and are really more akin to blue-chip equity funds.

One laggard in the category is the $2-billion CI Signature Dividend Fund offered by Toronto-based CI Investments Inc., a preferred equity-based offering that has trailed most of its peers for some time. Let’s contrast it with the stalwart, $3-billion PH&N Dividend Income Fund, sponsored by Vancouver-based Phillips Hager and North Investment Management Ltd.

The CI fund’s average annual compound rate of return for the five years ended June 30 is a disappointing 7.3%, well behind the median fund’s 9.7% and the market as a whole, landing it in the fourth quartile. Year-to-date, the fund is up 2.1%.

The steadier PH&N fund has produced a five-year average annual compounds return of 10%, placing it in the second quartile. The fund is down roughly 1% so far this year.

As a result, the PH&N fund earns a four-star ranking from Morningstar Canada, with the CI fund rating only two stars. The PH&N fund’s ranking, mainly the result of excellent returns in 2002, makes it the more attractive of the two, but this doesn’t tell the whole story.

Most dividend funds employ one of two strategies: they are either conservative equity funds that lean toward higher-yielding common stocks; or they feature a wider mix of equities, income trusts, bonds and preferred shares.

The PH&N fund is clearly the former, while the CI fund falls into the latter category — particularly as it is one of the few funds still using preferred shares as its principal component.

CI’s Eric Bushell spent the early part of his career working for the former BPI Financial Corp., signing on with CI when it acquired BPI’s operation. Generally a “growth at a reasonable price” manager, he uses bottom-up stock-picking to construct his portfolios. He favours larger-cap stocks that offer sustainable and attractive yields with modest capital appreciation. In this fund, at least, that translates into preferred shares.

Although the CI fund’s exposure to preferreds has decreased over time, their 39% weighting remains dramatically above the 5% average for other dividend funds. The dwindling supply of quality preferreds has severely limited Bushell’s ability to add value, as have the most recent Bank of Canada moves because, like bonds, prices of preferreds move inversely to interest rates.

Compared with most other dividend funds, the CI portfolio has also been tilted away from energy and mining-related stocks and trusts, muting performance. As a result, the fund is now seeking unitholder approval to shift more assets into fixed-income and common stocks. As yet, income trusts do not play a significant role.

Dale Harrison heads up PH&N’s Canadian equities team. He joined the firm nine years ago from BMO Nesbitt Burns Inc., at which he was a financial services analyst. He, too, employs a GARP philosophy, looking for companies in industries with high barriers to entry, such as financials and industrials. No preferred shares here, thank you, nor will you find income trusts as a rule.

Presently, Bushell has roughly 27% of assets in the CI fund’s top 10 picks. The PH&N fund, despite holding many more positions among a much wider variety of asset classes, still plants a larger portion of its assets — recently, about 55% — in the fund’s top 10 holdings.

Although it is understandable that both funds should have sizable stakes in the financial sector, the degree to which they have committed is significant. The PH&N fund has 55% in the financial sector, whereas the CI fund holds 38%.

With a market weighting in energy and materials, the CI fund typically has had no exposure to technology and health-care companies and has been overweighted in utilities.

The PH&N fund holds far fewer energy issues, maintaining a modest 4.5% weighting, by far the lowest in the category. Aside from its big bet on financials, it leans toward consumer and industrial stocks.

@page_break@In recent years, Harrison has been adding more U.S. names to the PH&N portfolio, taking foreign content up to its current 24% level. He does not hedge the fund’s currency exposure. In contrast, although out-of-country assets account for only 14% of the CI portfolio, half of the fund’s foreign currency exposure is hedged.

The CI fund sports slightly higher price/book measure than its PH&N counterpart, producing a considerably higher dividend yield than the median dividend fund.

The PH&N fund has a standard deviation of 9.9 over the past five years, while the CI fund’s standard deviation is only 4.9, with the pendulum swinging even more in the CI fund’s favour in recent years. Again, in terms of risk, this level of stability sharply eclipses most other dividend funds.

In addition, the two funds’ relative five-year Sharpe ratios — 0.89 for the CI fund and 0.74 for PH&N — indicate the CI fund has been a decent risk-adjusted performer. Here, both funds are in line with the median fund.

Rising interest rates could be a problem for the entire dividend fund sector, but both funds could provide diversification to investors looking to lower their risk.

The PH&N fund’s history and costs — at a modest 1.15%, its MER is roughly half the category’s median — suggests it is more worthy of attention. As well, the CI fund’s planned shift to holding more fixed-income could have tax implications for some unitholders, as interest income is taxed less favourably than dividends.

Overall, however, the CI fund’s revised mandate would give the highly regarded Bushell more avenues to add value through both security selection and asset allocation, says Morningstar, suggesting the CI fund may still appeal to risk-averse investors more interested in stability than absolute returns. IE