Brian McMahon, Thornburg Investment Income Builder

Age: 53

Credentials: B.A. in economics and Russian studies, U. of Va.; MBA, Dartmouth

Experience: chief executive officer and chief investment officer, Thornburg Investment Management (2008-present); portfolio manager, Thornburg Investment Management (1984-present); vice president, corporate finance, Northwest Bank (1979-1984).

Ticker: TIBAX

Inception of fund: December 2002

Style: World Allocation

Assets under management: $2.6 billion

Three- and five-year performance as of May 22, 2009: -3.3%, 5.7%

Expense ratio: 1.25%

Front load: 4.5%

Minimum investment: $5,000

Alpha: 0.51% vs. Dow Jones Moderate Portfolio

Dividend-paying stocks are usually a good bet. Securities in the S&P 500 that consistently initiated or boosted dividends gained 10.4% on average since 1972; those that didn't returned 8.2%, according to Ned David Research.

Today, however, one after another, companies have cut or suspended their dividends—particularly those in the financial services sector. That sector alone accounted for 30% of dividends paid out in the S&P a year ago. In the first quarter of 2009, S&P reports, 367 companies cut or eliminated dividends, 342% more than in the first quarter of 2008. It's the first time that cuts outpaced increases since S&P began tracking the data in 1955.

For a fund whose strategy is finding securities with rising income streams, like the $2.6 billion Thornburg Investment Income Builder, this has been a big blow. For the year ended May 11, the fund is down 26%, in the bottom 46% of world allocation funds tracked by Morningstar. Things look slightly better longer term. For the three-year period the fund is off an annualized 3.3%, putting it in the top 39% of the category; over five years it's up an annualized 5.7% and in the upper 29%. Over the past 12 months the fund generated a 7.5% income stream.

Casting a Wide Net

As difficult as the recent market has been for dividend payers, managers Brian McMahon and Jason Brady were able to take advantage of the fund's flexible strategy to find income in other places.Today, just 55% of the portfolio is in dividend-paying stocks, a far cry from the 85% that the fund held a year ago. The remainder is in corporate, government, municipal and international bonds and preferred stocks—just about anywhere income can be found.

"Our shareholders want income," says Brady, who is responsible for the fund's fixed-income portion, while McMahon oversees the stocks. "They don't care how we get the income, but how much of it there is."

So Brady and McMahon shifted their attention to fixed income. "There's gobs of income right now like we've never seen in the bond sector and even in some preferreds, which is fortunate because the income in large chunks of dividend-paying stocks has dried up," Brady says.

Beginning last fall, when Lehman Brothers dumped billions of dollars of its securities in order to liquidate, Thornburg loaded up on non-stock fare. "For the market to absorb that kind of volume, something had to give and that was prices," McMahon says.

Bonds were too cheap to pass up. The fund owns so-called perpetual bonds issued by reinsurer Swiss Re. (They do not have a maturity date.) The prices on the bonds had fallen so much in late 2008 that they were yielding 15%. "If nothing moves, we make 15%, so they're attractive on an income basis," Brady says. "But the price will rise, so they're attractive on a total return basis too."

Similarly, the team added bonds issued by Deutsche Telecom, the German wireless company, to the portfolio. "In scary financial times, companies like these turn to financial support from their governments," Brady says.

What's more, the bonds were had for a 10% yield. "We will take that 10% yield and provide it to our shareholders for a long period of time, maybe over the next 10 to 15 years," he adds. The finds were so good that Thornburg Investment Income Builder was able to increase its own dividend to fund shareholders to $1.02 in 2008 from the 91 cents it paid in 2007. "I would never suggest that we can continue to increase it at the rate we were able to increase it last year," McMahon says. "That was unusual."

Making the Cut

To be sure, Thornburg Investment Income Builder still likes dividend paying stocks. They think it's a smart move for management to share its profits with shareholders rather than be tempted into ill-advised mergers. After drug maker Pfizer moved to buy Wyeth in January for $68 billion in cash and stock, it announced a dividend cut shortly afterward. "If people have capital discipline, that's a better indicator of good executive and boardroom behavior than holding retained earnings," McMahon says.