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What Active Management Can Bring to Dividend Investing

A forward-looking active manager may be able to sidestep companies and areas of the market where dividends are at risk, says Fidelity's Ramona Persaud.

Mike Rawson: Hi, I'm Mike Rawson for Morningstar. I'm here today at the Morningstar ETF Conference talking about dividend investing with Ramona Persaud. Ramona is the portfolio manager of Fidelity Dividend Growth (FDGFX) and Fidelity Global Equity Income (FGILX). Ramona, thanks for joining me.

Ramona Persaud: Thanks.

Rawson: Ramona, there are a lot of dividend ETFs out there that use a basic screen, a quantitative approach, to select stocks, but they have no active manager oversight to try to capture what might be value traps. In your opinion, what value can an active manager add to a basic dividend ETF?

Persaud: Particularly in dividend investing, I think it's really important to take an active approach. The best example of that recently is financials in 2007 and into 2008, where if you were passively or rotely focused on dividends, you would have ended up with a fund that was 35% to 40% financials versus the market, which was more like 10% to 15%. You would've experienced massive drawdowns in that sector, a lot of which had to do with dividend cuts, versus if you were actively managing a fund and, with good fundamental analysis, figured out that financials were not the place to be. So, I think active can help you, in that particular case, for instance, avoid dividend cuts. An interesting statistic on dividend cuts is that 12 months going into a dividend cut, you underperform, on average, by 25%. That's really huge. So, an active approach that is forward looking can help you to avoid dividend cuts. You can also, in a dividend strategy, focus on dividend growth with a forward-looking approach by being active. So, if you can find companies where free cash flow generation is becoming better, more reliable, more predictable, and greater--and, therefore, the predictability of dividend initiations or dividend increases is more straightforward--you can actually get ahead of a passive strategy that would invest in a company like that on a look-back basis.

Rawson: Ramona, you've talked about your investment philosophy as really relying on three pillars--three things that you really look for in a dividend-paying stock. Can you discuss those three pillars?

Persaud: Sure. My investing belief system is focused on, very simply, that value investing wins over time. If you're focused on trying to generate alpha or excess return, really the best predictor of excess return over time is valuation. Value is just a fancy way of saying low-expectation investing. And as with all things in life--and certainly in investing--your odds of beating expectations are better if they start out low than if your expectations are high. Value is just low expectations. The problem with value is that it comes with a lot of volatility. So, to the extent that you're running a dividend-oriented strategy, you really want to mitigate the volatility in your return stream, given who the core investor is. What I try to do is combine value with quality, because my focus is risk-adjusted return, not just return. And because it is a dividend strategy, the third pillar of my investing philosophy is capital allocation. So, what does a company do with the free cash flow they generate? They can pay dividends, they can do buybacks, they can reinvest in the business. I want them to do whatever is best for shareholders of those three choices.