Royce and Associates’ Charlie Dreifus, whose Royce Special Equity fund is in the top 11% of its category over the past ten years and the top 5% over the past five years, says dividends “will be a powerful theme for the future” for stock investors.

“Our basic hypothesis is that companies with a moderate current yield, increasing dividends, and reasonable valuations and are also financially productive are more likely to produce market-beating returns,” Dreifus tells Morningstar. “The alpha we see coming from increasing dividends is a function of several factors. One, sovereign debt downgrades have caused investors to seek high-quality substitutes. Two, an aging population is seeking income. Three, ongoing and rising dividends are a layman’s shortcut to determining earnings quality. All of these speak to the increasing importance of the dividend component of total return.”

Dreifus stresses that he’s not looking for the highest yielders, but instead “consistent dividend growers with supporting, solid free cash flow generation”.

While his Special Equity fund targets small-caps and micro-caps, Dreifus also manages the Royce Special Equity Multi-Cap fund, which debuted in 2011 and was in the top 3% of funds in its category last year, according to Morningstar. Right now, it’s in larger small-cap stocks that he says he’s finding the biggest opportunities. “For some time, we have found the larger small-cap names more attractive,” he says. “Some of that no doubt is because of the significant price appreciation in the smaller, lower-quality small-cap issues off the March 2009 bottom. This is the usual pattern after a decline and often leaves the larger quality names relatively neglected, which has historically worked well for us.”

Dreifus also talks about the rigorous battery of financial tests he puts his holdings through, and why he likes some names in the consumer cyclical sector.