Mixing Municipal Bonds, Blue-Chip Stocks
Sunday, June 25, 2006
As stock prices fall, Federated Muni and Stock Advantage Fund's R.J. Gallo and John L. Nichol are providing more protection for investors than their peers by buying municipal bonds and shares of companies that pay high dividends.
The Federated fund slipped 1.8 percent in the 6 1/2 weeks ended Wednesday, compared with the 6.2 percent decline of the benchmark Standard & Poor's 500-stock index. In the past year, the fund rose about 5 percent, exceeding the S&P 500's gain of about 4 percent and outperforming the average 0.5 percent drop of 195 "balanced funds" tracked by Bloomberg.
Gallo and Nichol have about 60 percent of the mutual fund's $572 million invested in muni bonds. The rest is in stocks such as AT&T Inc., the largest U.S. telephone company. The approach is paying off in the worst year for stock markets since 2002.
"The muni side is offering significant ballast to the portfolio," Gallo said from his office at Pittsburgh-based Federated Investors Inc.
Gallo, 37, a former analyst at the Federal Reserve Bank of New York, and Nichol, 43, who used to oversee pension funds for the Public Employees Retirement System of Ohio, are beating rivals at funds such as the $622 million Vanguard Tax-Managed Balanced Fund and the $373 million AllianceBernstein Tax-Managed Wealth Preservation Strategy.
The Federated fund has a Sharpe ratio of 0.43 in the 30 months ended May 31, compared with 0.14 for all U.S. "target allocation conservative" funds, according to Lipper Inc., the fund research unit of Reuters Group PLC. The greater a fund's Sharpe ratio, the better its risk-adjusted performance.
The fund holds about 100 stocks, whose average dividend yield is 3.1 percent, compared with 1.9 percent for the S&P 500. Nichol, who handles the fund's equity investments, buys companies with above-average cash flow and little debt.
The fund's biggest holding is Exxon Mobil Corp., the world's largest publicly traded oil company, followed by AT&T. Exxon stock, which closed Friday at $58.10 a share, gained 3.2 percent this year, including reinvested dividends, while shares of AT&T are up 16 percent, ending the week at $27.37 each. San Antonio-based AT&T has a 12-month dividend yield of 4.8 percent, more than double Exxon Mobil's 2.1 percent.
Nichol, who has a master's degree in business from Ohio State University, also owns shares of Houston-based Kinder Morgan Inc. The company, which pays a 3.3 percent dividend, is considering a $13.4 billion buyout led by co-founder Richard Kinder as high oil and gas prices spur acquisitions among energy producers. Kinder Morgan's shares are up 10 percent this year and closed Friday at $99.54.
The fund's other holdings include Loews Corp.-Carolina Group, controlled by New York's Tisch family. Shares of the company, which reflect the performance of Loews's Lorillard cigarette unit, have gained 14 percent this year. Carolina Group has a 3.7 percent dividend yield. The stock ended the week at $50.49 a share.
On the debt side, the Federated fund typically invests in bonds that mature in 10 years or more. As of May 31, 65 percent of the fund's muni-bond holdings had a credit rating of at least A from Standard & Poor's. The fund's five top bond holdings pay interest of at least 5 percent a year.
Gallo, who has a bachelor's degree in economics from the University of Michigan at Ann Arbor and a master's degree in public affairs from Princeton University, owns $5 million worth of AAA-rated Chicago Metropolitan Water Reclamation District bonds, which have a 5 percent coupon and mature in 2028.
Another holding, an insured Denver Convention Center Hotel Authority revenue bond, has a 5.125 percent coupon and matures in 2024. Because the insurer is a relative newcomer to the market, the bond's yield is higher, Gallo said.
"When you start going a little off the beaten path in munis, sometimes you can find what I would call inefficiencies in the market," he said.
Federated started the fund in September 2003, four months after the U.S. government reduced taxes on dividends to a maximum of 15 percent from as much as 38.6 percent.
The Federated fund may appeal to investors seeking lower taxes, said Tom Roseen, a Denver-based analyst for Lipper.
"People are going to start caring again about taxes," said Roseen, who published a study in April that found investors lose as much as 2.4 percentage points of annual gains because of taxes.