DOD vs. DIA: A Better Dow Jones ETF?

by on April 5, 2010 | Updated November 6, 2012 | ETFs Mentioned:

When reporting on the performance of the U.S. stock market, everyone from the Wall Street Journal to local anchormen generally refer to the Dow Jones Industrial Average, one of the oldest and most widely-recognized stock benchmarks. So it’s not surprising that one of the most popular ETFs available to U.S. investors is the Dow Jones Industrial Average ETF (DIA), a fund that tracks the storied blue chip benchmark. DIA has about $10.5 billion in assets and an average daily volume of more than 4 million shares. The underlying index, which has been around since the late 1800′s, consists of 30 large blue chip U.S.-listed companies [see Free Report: How To Pick The Right ETF Every Time].

The rise of indexing as an investment strategy (and ETFs as an investment vehicle) has spurred the creation of countless new benchmarks, including several “spin-offs” of well-established  indexes. One example is the Dow Jones High Yield Select 10 Index, which is linked to the ELEMENTS Dogs of The Dow ETN (DOD). This index is based on an investment strategy introduced in the 1990′s by money manager Michael O’Higgins in the book “Beating the Dow.” O’Higgins promoted a strategy of investing in the ten DJIA components with the highest dividend yield, and rebalancing holdings on an annual basis.

The index underlying DOD is an equal-weighted benchmark, meaning that each component is initially given the same weighting upon selection in December of each year. In this way, DOD addresses an oft-mentioned drawback of the Dow 30, a price-weighted benchmark [see The Problem With Dow ETFs]. Currently, DOD’s components include Procter & Gamble, Johnson & Johnson, DuPont, Verizon, Merck & Co., Kraft, AT&T, Pfizer, GE, and Intel. These companies have an average dividend yield of about 3.65%, well ahead of the 2.46% dividend yield on DIA [ETFdb Pro members can access the Monthly Dividend ETFdb Portfolio, sign up for a free 7-day trial to get full access].

Over the trailing 3-year period, DOD’s focus on dividend-paying equities has given it an edge over DIA. The Dogs have added about 60% over the last three years, compared to 33% for the more traditional Dow ETF.

Different…But Better?

So is DOD a better Dow Jones ETF than DIA? It’s certainly an interesting option for dividend-hungry investors, but those looking to establish exposure to blue chip U.S. companies may want to think twice, as there are a handful of potential drawbacks to investing in the “Dogs of the Dow.” First, as the name of the underlying index suggests, the underlying index consists of just ten names, making DOD one of the most concentrated equity ETFs available (the B2B Internet HOLDRS, which has just two component stocks, holds the title in this area). Because returns depend on the performance of only ten companies, DOD can be influenced by company-specific events, something many ETF investors generally try to avoid.

DOD is also very thinly-traded, with an average daily volume of a mere 15,000 shares. While limit orders and the services of alternative liquidity providers make it possible to make big trades in “illiquid” ETFs for a relatively low fee, some investors are hesitant to invest in funds that don’t meet a certain liquidity threshold.

It’s also worth noting that DOD is an exchange-traded note, meaning that it is a senior unsecured debt instrument that comes with credit risk. In this case, the debt is issued by Deutsche Bank, meaning that a default is unlikely (although holders of ETNs issued by Lehman likely thought the same thing in 2008).

A closer and longer look at the performance levels of these two funds reveals DOD’s resilience over the last few years; since inception in late 2007, DOD has outperformed DIA by about 6%.

 

Finally, DOD charges an expense ratio of 0.75%, significantly higher than the 16 basis point fee of DIA, which is among the lowest in the industry.

The Verdict

While DOD presents an interesting investment case, investors with lower risk tolerances looking for blue chip exposure will generally be better off sticking with the original Dow Jones ETF. If you’re really set on using ETFs to capture a juicy dividend yield, look into one of the dividend-weighted funds from WisdomTree or handful of funds from other issuers that focus on dividend-paying stocks. But for those willing to stomach some additional risk, DOD’s performance compared to DIA’s over the last few years certainly warrants a closer look [see also Highlighting Seven Unique Dividend ETFs].

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Disclosure: No positions at time of writing.