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High Yield Stocks Overrated? How Hedge Funds Are Trading High Yielders

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It is anticipated that the Federal Reserve will raise interest rates very soon in spite of concerns about the lower-than-expected growth of the U.S. economy.  Therefore, an increase in interest rates could negatively affect the slow-growth stocks that generate returns predominantly through dividends and interest. Actually, the performance of the stocks that have high dividend yields is discouraging this year regardless. A recent study from Bespoke Investment Group, which has broken down the S&P 500’s constituents into deciles based on dividend yield, concluded that the group containing the highest dividend-yielding stocks are down by an average of 5% year-to-date. In the meantime, the decile containing the stocks with no dividend yields is up by 9.8%. However, hedge funds often prefer to invest in dividend-paying stocks, because they are usually financially strong companies and offer a regular payoff aside from longer-term stock appreciation. In this article we will take a look at three stocks with high dividend yields, in which hedge funds held long positions as of the end of March. They are Dynex Capital Inc. (NYSE:DX), SunCoke Energy Partners L.P. (NYSE:SXCP) and Northern Tier Energy LP (NYSE:NTI).



We track hedge funds and prominent investors because our research has shown that historically their stock picks delivered superior risk-adjusted returns. This is especially true in the small-cap space. The 50 most popular large-cap stocks among hedge funds had a monthly alpha of about six basis points per month between 1999 and 2012; however the 15 most popular small-cap stocks delivered a monthly alpha of 80 basis points during the same period. This means investors would have generated ten percentage points of alpha per year simply by imitating hedge funds’ top 15 small-cap ideas. We have been tracking the performance of these stocks since the end of August 2012 and these stocks have beaten the market by 85 percentage points (145% return vs. S&P 500’s 60% gain) over the last 34 months (see the details here).

Dynex Capital Inc. (NYSE:DX) pays an annualized dividend of $0.96 and has a dividend yield of 12.3%. At the end of the first quarter, only six hedge funds from our database held positions in the company, compared to seven at the end of the previous quarter. At the same time, the value of their positions declined to $8.55 million from $9.73 million a quarter earlier. Meanwhile, Dynex’s stock has decreased by 5% since the beginning of the year. The company is an internally managed mortgage REIT (real estate investment trust) that invests in residential and commercial mortgage securities by using leverage. Since Dynex’s primary source of income is net interest income, which represents the excess of the interest income earned on its investments over the cost of financing those investments, the company’s earnings might be impacted by an increase in interest rates. Within our database, Israel Englander’s Millennium Management is among the largest shareholders in Dynex Capital Inc. (NYSE:DX), with 106,119 shares.

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