NEW YORK-As the economy slows, as expected in 2007, Eaton Vance wants investors to think big.

"Investors have paid way too much attention to small-caps," said Vice President and Chief Equity Investment Officer Duncan W. Richardson during a presentation here last week.

Richardson encouraged investors to consider large-cap funds, while increasing their equity exposures by between 5% and 10% in lieu of flocking to fixed income. Such strategies mark a shift from recent years, in which small-caps have delivered stellar performance, and large caps lagged.

"It's not because this investment style is long in the tooth but because the economics are shifting," said the value-oriented top-stock-picker of the Boston-based shop.

Between 2000 and June 2006, the large-cap Russell 1000 Growth Index slipped, on average, 6.5% each year, while the small-cap Russell 2000 climbed more than 7%.

As a result, small-caps, which historically trade at a 2% discount to their blue-chip counterparts, have commanded, on average, 6% more, said Michael R. Mach, a vice president who manages the company's Large-Cap Value and Tax-Managed Value funds.

But an economic slowdown will cool small-cap spending and, therefore, performance. At the same time, low interest rates will mean little growth for fixed income bond funds. Richardson projects those rates, which have not crept above 6% since the millennium, are likely to stay somewhere between 4% and 5% indefinitely.

This new economic climate offers great opportunities for income-oriented investors, he said, touting his company's reputation as an expert in niche tax-management and dividends.

Big companies have strong balance sheets right now, noted Judith A. Saryan, vice president and manager of Eaton Vance's Tax-Managed Dividend Income Fund and its Utilities Fund.

Add to that the 2003 changes to the tax code, which slashed the rate on dividends from 38% to 15%, and strong market performance becomes even more competitive with staid fixed-income returns, she noted.

And while dividend-paying stocks typically outperform non-paying stocks by 300 basis points a year, dividend-paying stocks that also grow in value each year tend to outperform non-dividend-paying stocks by 600 basis points annually.

By marketing its funds as an alternative to fixed income, Eaton Vance hopes to lure retirees who already control 62% of assets to invest in this country, a figure expected to reach 70% by 2020.

While this strategy may work well for Eaton Vance investors, who rely on investment advisors when buying funds, it can be somewhat risky for the do-it-yourselfer, said Andrew Clark, a senior research analyst with Lipper.

Certain classes, such as utility funds and real estate investment trusts, have been reliable dividend-payers for years, but the large-cap climate could change. And while individual stocks can be pretty predictable, large-cap, dividend-paying funds, as a whole, may be a little more volatile. Individual investors who fail to rebalance regularly can miss out, or worse, expose themselves to greater risk.

Finally, Clark said, "Forecasting interest rates is one of our great unsolvable problems. Do you really want to hang your hat on that if you're a retiree?"

Still, Eaton Vance's experts believe the trend toward more big companies paying dividends will continue. For one thing, only about 32% of stocks pay dividends-the lowest ratio in half a century, compared to the average dividend ratio of 50%.

Furthermore, there's the "silver lining of Sarbanes-Oxley," Richardson said. The law's reporting requirements have helped many companies better align their balance sheets. "Companies really know where their costs are," he said, "large companies especially."

And dividends are the one part of that balance sheet no company can restate.

While recent laws have made for higher-quality company earnings, competition from private equity has also stoked companies to share more of those earnings with investors in the form of dividends.

Companies with extra cash on their balance sheets can make capital investments, acquire other companies, grow their own operations or pay dividends. With the $2 trillion private equity marketplace looking for acquisitions, companies that pay dividends, which tend to buoy share prices, can stave off such raids.

"It puts corporate management in a position with their feet to the fire to use the balance sheet to create value for shareholders," Mach said.

There are few values shareholders like more than the total return of increased share value and cash dividends, which adds to the good news for investors of large companies, he said.

Richardson also encouraged investors to think locally in 2007. The American market is undervalued, while foreign companies might be reaching their saturation points. Citing data from Minneapolis-based Leuthold Group, Richardson said that 91% of the $158 billion investors pumped into equities last year went overseas. Meanwhile U.S.-equity holding funds saw outflows.

(c) 2007 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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