Fund Managers Dive Into Stocks

By Jane J. Kim

With bond yields near historic lows, some managers of global-allocation mutual funds say stocks are starting to look like better alternatives.

In the past few months, several large funds—including BlackRock Global Allocation Fund /zigman2/quotes/201354227/realtime MDLOX -0.46% , Franklin Income Fund /zigman2/quotes/206821089/realtime FKINX -0.44% and American Funds Capital Income Builder Fund /zigman2/quotes/205848678/realtime CAIBX -0.17% —have been moving back into equities.

"Many managers believe stocks now offer better relative values than bonds," says Kevin McDevitt , mutual fund analyst at investment-research firm Morningstar /zigman2/quotes/209325896/composite MORN -0.70% Inc. "They're not reflexively buying bonds just to keep investors safe—they are thinking opportunistically as well."

Bonds have been on a historic rally this year, with the yields on some Treasurys and corporate issues falling to record lows. Year-to-date through August, investors poured $168.4 billion into taxable bond funds, while domestic equity funds continued to bleed assets, with $42.2 billion in outflows over the same period, Morningstar says.

As bond prices soar, however, some money managers are turning to dividend-oriented stocks as surrogates. For example, the BlackRock Global Allocation Fund, which has held, on average, about 50% in equities over its 21-year history, now holds close to 60%. "It's understandable that investors are clamoring for yield and the perceived safety of the bond market, but the reality is that one can find pretty compelling yields in the equity markets," says Dan Chamby , associate portfolio manager of the $43.7 billion fund.

The $52 billion Franklin Income Fund, which is more U.S.-focused, has switched from about 70% fixed income and 30% equities last year to roughly 60% fixed income and 40% equities. That is because there are now more opportunities in dividend-paying stocks than bonds, says co-manager Edward Perks .

"Historically, we have been more confined to certain sectors of the economy, such as utilities," he says. "Now, we have a bit more breadth in sectors such as financials, telecommunications, energy and health care."

It helps that companies are boosting their dividends. Even growth-oriented technology firms, which have historically shunned dividends, are jumping aboard. In September, for example, Cisco Systems /zigman2/quotes/209509471/composite CSCO -0.61% Inc. said it will begin paying a dividend in the 1% to 2% range.

Some companies are now paying higher yields on their stocks than they are offering on their debt. In late August, the 10-year U.S. Treasury fell to 2.48%, compared with a dividend yield of 3.2% for the MSCI EAFE Index.

"You can go out and buy the bonds of a company that might pay you 3% or 4% for three or five years, but the dividend yields of the stocks might be higher and may grow," says Kimball Brooker, associate portfolio manager of the $8.5 billion First Eagle Overseas Fund /zigman2/quotes/209014684/realtime SGOVX -0.13% , who has been lightening up on the fund's bond positions in recent months in favor of stocks. "Generally speaking, there have been bigger discounts to intrinsic values and more interesting investment opportunities in stocks."

BlackRock's Mr. Chamby holds telecom companies such as Verizon Communications /zigman2/quotes/204980236/composite VZ +0.60% Inc., which yields close to 6%. He also likes Johnson & Johnson /zigman2/quotes/201724570/composite JNJ +0.44% , which recently issued 10-year debt yielding 2.95% while the dividend yield on its stock is about 3.5%. Mr. Chamby points to overseas opportunities as well, such as Japan's NTT DoCoMo Inc., whose dividend yields are about triple the yields on 10-year Japanese government bonds.

There are risks to those dividends, of course. While they are boosting payments now, companies can cut them anytime.

Another wild card: taxes. If Congress fails to extend the Bush-era tax cuts—including a 15% tax rate on qualified dividend payments—the top dividend tax rate could jump to 39.6% next year. James Steiner , managing principal of Lowry Hill, a private asset-management firm in Minneapolis, is in the process of increasing the overall weight of dividend-paying stocks in clients' portfolios, on the belief that a greater percentage of the total return will come from dividends over the next 10 years. But he is doing so slowly because of the tax-policy risk.

Yet for many managers, the relative values in stocks are outweighing the risks. Even bond giant Pacific Investment Management Co. has increased its overall allocation to equities in the $2.4 billion Pimco Global Multi-Asset Fund /zigman2/quotes/200236637/realtime PGMAX -0.49% , to 48.5% in August from 43.7% in July.

Of course, compared with a traditional 60% stock/40% bond allocation, the fund remains defensively positioned—underweight stocks and overweight bonds, with a tilt toward emerging markets. It seeks to exploit what managers believe to be "safer sources of equity-like returns," says Mohamed El-Erian , chief executive and co-chief investment officer of Pimco.

Still, the fact that the firm famous for its belief in a "new normal" of muted growth in the U.S., stubbornly high unemployment, onerous reregulation and the ascendance of emerging markets is increasing its equity holdings shows that when bonds are looking bubbly, there may be pockets of opportunity in stocks.

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