Under The Microscope: Dividend Rotation ETF (IRO)

by on May 6, 2010 | ETFs Mentioned:

With markets struggling as of late, value investing has seen a spike in popularity. Virtually all asset classes have been pummeled over the last week, as the debt crisis in Greece and the oil spill in the Gulf of Mexico continue to weigh on markets around the globe, pushing equity prices down sharply in particular (see Six ETFs To Watch As The Greek Drama Unfolds). These recent losses have helped to highlight the usefulness of dividend paying equities and how they can help to protect a portfolio in a sudden downward spiral plunge.

However, dividend investing is not as simple as it once was. The number of companies paying steady dividends has shrunk dramatically thanks to the financial crisis and a premium on maintaining a “rainy day fund.” Moreover, many technology firms refuse to pay out dividends despite having war chests of cash running in the billions. This trend has made tracking down high dividend yields difficult, and increased the appeal of ETFs that do the legwork for investors. Currently there are a variety of ETFs focusing on dividend paying equities, including funds that focus on international securities, companies that are consistently raising dividends, or even stocks that track companies across a variety of asset classes (see the Ultimate Guide To Dividend ETFs). One often overlooked option available to investors seeking to maximize their dividend income is the Claymore/Zacks Dividend Rotation ETF (IRO).


IRO offers investors access to dividend paying companies by tracking the Zacks Dividend Rotation Index, which seeks to maximize dividend income that qualifies for taxation at the lowest current tax rates. The index is comprised of approximately 100 stocks selected from a universe of the 1,500 largest listed equity companies that pay dividends at least annually and have market capitalization between $200 million and $450 billion. The index seeks to maximize qualified dividend income or “QDI” by selecting dividend- paying stocks based on a quantitative methodology proprietary developed by Zacks. Unlike most dividend ETFs, at the time of each rebalance IRO will eliminate companies that have recently paid a dividend and include those companies that are expected to pay dividends in order to maximize QDI potential (for other little known ETF stars, see The Ten Best ETFs You’ve Never Heard Of).

The fund achieves this goal by splitting the index into two equal sub-indexes of 50 stocks. At the rebalance date, the two sub-indexes alternate which will be rebalanced so that each sub-index is held for a period of two months. This holding period is designed to maximize QDI potential, as the stocks are included in the index prior to their dividend period and are held for approximately 61 days, which is greater than the required holding period for dividend income from such stocks to be considered QDI. At the time of the rebalance, all stocks that have paid a dividend in the last 30 days or are included in the non-rebalanced half of the sub-index are eliminated from the universe of potential constituents.

Each company is then ranked using a quantitative, rules-based methodology that includes likelihood of a dividend payment in the next 30 days, yield, liquidity, company growth, relative value, payout ratio and other factors. The 50 constituents of each sub-index are then chosen and are weighted based on liquidity and yield. The process is then repeated on a monthly basis to alternating sub- indexes and then rebalancing to restore the sub-indexes’ allocation to approximately equal is conducted annually (also see this Guide To Alternative ETF Weighting Methodologies).


Based on the description above, it probably isn’t surprising that IRO’s holdings turn over quite regularly (see IRO’s holdings here). Currently, IRO has a heavy focus on utilities and financials which combine to make up 53.8% of the fund’s assets. The company is underweight in technology and business service firms, since those firms have not historically been big dividend payers. The fund is pretty well spread out across market capitalization levels with small caps edging out mid caps by a margin of 25.4% to 23.3% to make up the largest part of the fund (for more discussion on market cap levels, see Is Bigger Always Better?).

Return and Fees

IRO has performed well thus far into 2010 posting a gain of 6.1%, beating out both SPY and Vanguard High Dividend Yield ETF (VYM). Over the past 52 weeks, IRO outperformed as well, beating the two by an even wider margin. The fund charges an expense ratio of 0.60% (see more fundamentals of IRO here).

IRO is relatively small, with assets of about $9 million and an average volume of just 6,200 shares. This suggests that investors should use caution–and limit orders–when establishing a position.

If you’re looking to add dividend-paying stocks to your portfolio, there are plenty of options available. Among these, IRO is unique for its focus on QDI income and frequent rebalancing, a combination that has produced stellar returns in recent periods (see more on IRO’s fact sheet).

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Disclosure: No positions at time of writing.