Asset-Class Agnostic

History tells us that dividends—the cold, hard cash paid out to shareholders as a portion of a company’s profits—play an important role in the total return from the stock market. Dividends are taxed at a rate of 15 percent and can provide a valuable component of a total-return strategy for a taxable investor.

Tealwood Asset Management in Minneapolis has amassed a solid track record for clients during its 20 years in business by focusing on a value-oriented approach to investing that emphasizes both the potential for capital appreciation in a stock or a bond—along with the all-important dividend or interest payment.

Charlie Mahar, president of Tealwood, and Ken Dawkins, a longtime bond fund manager with the firm, co-manage Tealwood’s Strategic Income Portfolio. Tealwood also manages equity portfolios more oriented to a capital-appreciation strategy in both the large- and the middle to small–capitalization asset classes.

{Q} With domestic economic growth slowing down, investment managers have argued that large-capitalization companies are best positioned to deliver the most robust returns to investors. Your portfolio suggests a different approach.

{DAWKINS} Our goal is to go everywhere and to use many different asset classes. For instance, we started out with a lot of convertible bonds. But then convertible bonds became expensive, and we were on to other things: common stocks, closed-end mutual funds, convertible preferred stock, energy partnerships, and a couple of corporate bonds.

The goal of the portfolio is to generate an 8 percent return per year: 5 percent through income sources, such as interest from bonds or dividends from stocks, and 3 percent through growth. We have been fortunate to generate average annual returns of over 13 percent annually since inception, but we have not reached for more risk to chase returns.

{MAHAR} The equity portion of [Tealwood’s] Strategic Income Portfolio will never be more than half of this portfolio because we’re trying to differentiate it from an all-equity or an all-fixed income strategy.

{Q} Do you believe that the current economy favors certain asset classes over others, given its current shape?

{MAHAR} We have the wonderful privilege of being flexible enough that we can be asset-class agnostic. We are much more interested in first-rate investment opportunities than we are in asset-class dogma. If we find opportunities more oriented to small caps or large caps, we’re going to go with the opportunity and not think about asset classification first.

I happen to believe that in the large-cap world, we are going to have an environment of flat multiples, and your return is going to reflect your profit growth. So, if you get 6 percent profit growth, which is the projected profit increase on the Standard & Poor’s [S&P] 500 for 2007, you’re going to get that, plus dividends. We don’t find that to be an enticing argument for most large-cap stocks.

{Q} Where are the enticing opportunities?

{DAWKINS} Among our stocks, we own mostly large-cap foreign businesses at the moment. For instance, we bought Telefonica [NYSE: TEF], the Spanish telephone company, because at that time—about 18 months ago—the company had a 5 percent yield and a management team that was committed to doubling the dividend in four years. We bought the stock in the low $40s, and it’s up to $58 or so now, and the dividend has been increased once. I think within four years, we are going to have a 10 percent yield on the original investment.

{Q} Do you believe the name of the game now is income as a portion of the return?

{MAHAR} In this strategy, our objective is income first, appreciation second, and manage risk along the way. We believe that the income portion of your total return—the dividends and interest—are, once again, important to your overall return. Historically, over the 80-year time period in which we have data on the S&P, dividends have been 40 percent of the market’s 10 percent return.

{Q} Given the fact that interest rates are on the rise, is fixed income going to be an underweighted area of focus?

{DAWKINS} We are underweighted in fixed income.

{MAHAR} We have a whole portfolio dedicated to an income strategy, and out of the 25 investments in the portfolio, only two are specifically in fixed income.