The Case for Dividend-Tracking ETFs
While low interest rates and volatile market conditions have pushed many investors into high-yield corporate debt ETFs like SPDR Barclays Capital High Yield Bond (JNK) or inflation-fear funds like SPDR Gold Shares (GLD), there is still a strong case to be made for a core investment in companies that have high dividends and offer income over time.
High-dividend-yielding companies may not always be the most exciting to watch, but they can provide a steady stream of income and value to a well-diversified portfolio. Included in my new ETF Action Portfolio is the Dow Jones Select Dividend Index ETF (DVY), an ETF that tracks approximately 100 of the highest dividend-yielding companies.
High yield can often go hand in hand with high risk, and this ETF is designed to screen dividend-paying companies before including them in the portfolio. The highest dividend-yielding stocks are often companies that have fallen hard and fast in the market, so it is important to have some type of selection process to weed out the more dangerous options.
DVY tracks the Dow Jones Select Dividend Index, and does not include companies that have cut their dividends in the past five years or paid more than 60% of earnings in the form of dividends. REITs, which often pay high dividends but are extremely risky, are omitted altogether.
Currently, DVY’s top10 holdings include Lorillard (LO), Eastman Chemical Company (EMN), PPG Industries (PPG), Kimberly-Clark (KMB) and Eaton (ETN). The most heavily weighted sectors in the portfolio are utilities, consumer goods, industrials and financials, with 23%, 20%, 19% and 12% allocations, respectively. The fund has a reasonable expense ratio of 0.40% and a relatively balanced portfolio, with less than 20% of total assets allocated to the top 10 holdings.
America’s population is aging. As investors move toward retirement and look for income-generating funds, it is important to choose funds that not only currently pay a high dividend, but also have expectations of continuing to pay dividends and grow payouts. DVY’s screening process helps to screen for consistent dividend payers who will not flame and burn out overnight.
DVY’s top holding LO saw earnings impacted by the financial turndown, but managed to gain market share in one of its discount brands. LO’s flagship brand, Newport, has maintained a loyal following, while discount brand Maverick gained market share during the economic slowdown. Sales of cigarettes and alcohol have traditionally been recession-resistant, and LO has a strong industry presence.
Eastman Chemical, DVY’s second-largest holding, had strong third-quarter earnings on the back of strong results from its CASPI and fibers segments. Lower prices for raw materials helped to improve the firm’s profit margin. EMN, whose goal is to increase chemical production derived from coal to 50% from 20%, has strong prospects for the next couple quarters.
Alternatives to DVY include the SPDR S&P Dividend ETF (SDY) and the WisdomTree Total Dividend ETF (DTD). Out of these three funds, DVY has the highest trading volume. SDY has a similar sector allocation to DVY, but half the number of underlying holdings. SDY and DTD have 0.35% and 0.28% expense ratios, respectively.
