Fund Watch


Best Funds for Blue-Chip Stocks

Elizabeth Ody

These funds own household names that should continue to perform well and pay dividends in any economy.



Fiscal cliff, shmiscal cliff. When it comes to investing, you can either sweat over the day's news and what it might mean for your stocks, or you can choose investments that will thrive, or at least not cause you horrific losses, no matter what the course of current events.

SEE ALSO: Our Slide Show of Stocks That Refuse to Die

Blue-chip stocks offer one such solid bet. Large companies with durable business models and sustainable competitive advantages should continue to grow and pay dividends even if the market takes a turn for the worse. Consider Johnson & Johnson (symbol JNJ). A majority of its products are number one or number two in their niches, and the company has increased its dividend in each of the past 50 years. Or take International Business Machines (IBM), which has generated higher free cash flow (the cash profit left over to pay dividends, buy back shares and make acquisitions) in each of the past nine years and which gets about 65% of its revenues overseas. Such stocks tend to be less volatile than those of less-established businesses. And many sport lower price-earnings ratios than the overall stock market.

Plenty of fine funds invest in blue-chip stocks, including two members of the Kiplinger 25. Fidelity Contrafund (symbol FCNTX), managed by the estimable Will Danoff, invests in large, high-quality businesses in part out of necessity. With $82.2 billion in assets, Danoff needs to target big firms to put his cash to work efficiently. He likes to let winners run, which means his top holdings read like a who’s who of shining stocks. Contrafund is the largest fund investor in Apple (AAPL), Google (GOOG) and Berkshire Hathaway’s Class A shares (BKR-A), which represent its three largest positions. The fund manages to achieve broad diversification, holding 364 companies at last report, without behaving like an index fund. Its 9.2% annualized return over the past ten years beat the S&P 500 by an average of 2.6 percentage points per year (all returns are through August 1).

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By contrast, Vanguard Dividend Growth (VDIGX) targets blue chips by design. Manager Donald Kilbride seeks companies that he thinks will raise dividends in the future, considering both stocks that already offer handsome payouts and ones that don’t. That leads him to firms that generate predictable streams of cash and that are run by executives who have demonstrated a commitment to raising dividends. The fund, which yields 2.1% , charges below-average annual expenses of 0.31%. Since Kilbride took the helm in February 2006, the fund has returned 6.1% annualized, compared with 3.3% for the S&P 500.

Donald Yacktman is holding a bushel of blue chips because, he says, they’re as cheap as they’ve ever been in his more than 40 years in the investing business. Yacktman, who co-manages Yacktman Fund (YACKX) and the more-concentrated Yacktman Focused Fund (YAFFX), looks for companies that earn high returns on capital -- a measure of how effectively firms use borrowed and invested money -- and for executives that he believes do a good job of reinvesting cash generated by their business.

Yacktman’s top holdings recently included PepsiCo (PEP) and Procter & Gamble (PG). Yacktman says he likes Pepsi’s diverse roster of brands, which include Gatorade, Tropicana and Quaker Oats, plus the company’s strong foreign presence (almost half of sales come from abroad). And he likes P&G because it leads in so many categories. Two dozen of its brands, including Pampers diapers and Head & Shoulders shampoo, generate more than $1 billion in sales annually. And P&G is the world’s largest provider of beauty and grooming products, with 18% of sales. “When you get to those kind of market positions, nobody can take it away,” says Yacktman. “All you have to do is execute halfway decently.”

The veteran manager has executed more than halfway decently himself. Yacktman Fund, which he manages with his son Stephen and Jason Subotky, returned 11.6% annualized over the past ten years, beating the S&P 500 by an average of 4.8 points per year. Yacktman Focused gained 11.7% annualized over that period.

Not only are large, high-quality companies inexpensive, they’re overdue for a run of market-topping returns, says Ron Canakaris, manager of Aston/Montag & Caldwell Growth (MCGFX). “Growth and yield are likely to be scarce in the period ahead, and these types of companies are simply better positioned to provide both,” he says. Canakaris and his team look for businesses that they believe can generate earnings gains of at least 10% annually over the next ten years, no matter what happens in the U.S. and global economies. Next they home in on companies that have experienced accelerating earnings growth in the past year. Finally, they rank stocks by the degree to which their share prices differ from their estimates of a company’s intrinsic, or true, value. The portfolio includes the 30 to 40 stocks with the best combination of growth and value.“We’re not willing to pay any price for growth,” says Canakaris.

That process has led to a high stake in consumer-staples companies. At last report, Canakaris had nearly one-fourth of his fund’s assets in the likes of Coca-Cola (KO) and Colgate Palmolive (CL), compared with an average of 9% among funds that invest in large, growing companies. But he has less in technology companies than his competitors -- 17%, compared with an average of 30% among Aston/Montag’s peers.

The fund hasn’t shot the lights out in the past ten years. Its 5.8% annualized gain trails the S&P 500 and peer funds by 0.8 percentage point and 0.6 percentage point per year on average. But its 8.5% annualized return since its inception in 1994 and strong performance during 2008, when it shed eight percentage points less than similar funds, make it a fine choice in our view.

For Robert Zagunis, co-manager of Jensen High Quality Growth (JENSX), quality is synonymous with profitability. He and his five co-managers will only invest in businesses that have generated a return on equity (a measure of profitability) of 15% or more in each of the past ten years. “These companies have been cranking it out regardless of the economic cycle,” Zagunis says. And he wants to see that a company he’s considering investing in generates sufficient cash to fund dividends and future growth.

Zagunis says that turmoil in Europe and economic slowdowns around the world will have little impact on the nuts and bolts of strong businesses such as his top two holdings, Pepsi and 3M (MMM), which makes everything from Scotch tape to orthodontic supplies. He says that criticisms of leadership at P&G, Jensen’s third-largest holding, are overblown and that CEO Bob McDonald should get credit for the company’s $10 billion cost-savings plan. And even though another big holding, Microsoft (MSFT), has been hugely disappointing over the past dozen years, Zagunis says that the company continues to grow in value and that investors will eventually acknowledge that.

There are large companies, and then there are enormous companies. Bridgeway Blue Chip 35 Index (BRLIX) holds the latter -- the average market capitalization of the fund’s holdings is $134 billion. The fund tracks a Bridgeway-designed index that equally weights the stocks of the 35 largest U.S. companies but modifies the list to avoid holding more than four firms from any one industry. The fund is generally rebalanced quarterly and reconfigured every two to three years, says co-manager John Montgomery. But Bridgeway, striving for maximum tax efficiency, will stray from strict equal weighting if it means the fund can better offset its capital gains with capital losses. “In 15 years, we’ve never distributed a capital gain,” Montgomery says. The fund has returned 6.2% annualized over the past ten years. Its expense ratio is a compellingly low 0.15% a year.

Too many choices? Go for simplicity. SPDR Dow Jones Industrial Average (DIA) is an exchange-traded fund that, not surprisingly, tracks the Dow. By definition, it holds almost every blue chip in the book, including ExxonMobil (XOM), IBM, Pfizer (PFE) and Wal-Mart Stores (WMT). Low 0.17% expenses, virtually no turnover of its holdings and a 2.5% dividend yield enhance its appeal. Over the past ten years, the ETF returned 6.8% annualized, narrowly beating the S&P 500.


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