Details Of Dividend ETFs: Consistency vs. Yield

by on July 27, 2011 | ETFs Mentioned:

In recent years ETFs have become increasingly popular as means of establishing cost efficient, low maintenance exposure to time-tested investment strategies. Russell recently rolled out a line of “investment discipline ETFs” that essentially automate the construction of portfolios consistent with various portfolio management techniques, including Growth at a Reasonable Price (GRPC), Contrarian (CNTR), and Low P/E (LWPE). It’s an advisor in an ETF wrapper, giving easy access to a number of different strategies.

In addition to these precise equity offerings, there are several exchange-traded products that allow investors to focus on securities that meet certain dividend-related qualifications. With interest rates in many developed markets remaining at or near historic lows, interest in alternative sources of current return has spiked in recent years. That has taken yield-hungry investors in a number of different directions, with many embracing dividend-paying equities as a way to enhance their portfolio’s yield without taking on excessive risk [see Dividend ETF Special: 25 Attractive Options].

There are dozens of ETFs offering exposure to dividend-focused strategies, including both domestic and international variations and products that focus on companies of certain sizes or within certain industries (as well as products such as the WisdomTree International Dividend ex-Financials Fund that avoid specific sectors). It goes without saying that these products are obviously not all identical; there are nuances to each that will have an impact on yield, volatility, and bottom line returns.

But there are also more basic distinctions in methodology that are critical to understand when evaluating potential dividend-focused ETFs. Not all dividend ETFs will strive to maximize dividend yields; some value consistency of payments over the magnitude of the effective yield. That distinction in methodology is an important one, as it has a big impact on the yield profile investors access.

Dividend Appreciation ETFs

The advice to never judge a book by its cover certainly holds up in the ETF industry; assuming that any ETF with “dividend” in the name will offer a huge yield may lead to some confusion. There are a number of funds that select holdings not on the size of the yield, but on the length and consistency of historical distributions:

  • Vanguard Dividend Appreciation ETF (VIG): This ETF seeks to replicate the Dividend Achievers Select Index, a benchmark that includes companies that have a history of increasing dividends for at least ten consecutive years. Top holdings include companies such as ConocoPhillips, Chevron, and Coca-Cola, along with a long list of blue chip stocks.
  • PowerShares Dividend Achievers Fund (PFM): This ETF is linked to the Broad Dividend Achiever Index, which includes companies that have increased annual dividends for ten or more fiscal years. Again, this fund is a collection of well known, large cap U.S. companies; the largest allocations include Procter & Gamble, Johnson & Johnson, and Wal-Mart.

Consistency vs. Magnitude

Any track record of increasing cash dividends paid to shareholders for ten consecutive years is impressive, and having accomplished that feat during the recent recession is particularly noteworthy. Such a history reflects a level of stability that most companies simply never reach. But it’s important to note the distinction between consistency of distributions and quantity of distributions; those firms that have regularly increased cash payments to shareholders won’t always be the stocks with the most attractive distribution yields–and in fact in most cases, they aren’t.

VIG recently had a 30-Day SEC yield of about 2.2%. By comparison, the more broad-based VOO, which seeks to replicate the S&P 500, had a 30-Day metric of about 2.0%. PFM has a distribution yield of about 2.4%, which is slightly below the comparable metric of 2.7% for the PowerShares Fundamental Pure Large Core Portfolio (PXLC).

In other words, these ETFs aren’t exactly making eye-popping distributions. And they shouldn’t be expected to; the underlying indexes are designed to select companies that are reliable sources of distributions–even if their dividend payments may not be as significant as other stocks. For investors who value stability of cash flows, this approach may be quite appealing. For those looking to maximize the effective dividend yield realized, this technique may obviously be less-than-optimal. Like almost any other ETP out there, products like VIG and PFM can be powerful tools if used correctly–but may disappoint investors who fail to grasp the objective of the funds.

ETFs To Max Out Dividends

There are, of course, ETFs that value quantity over consistency, focusing on stocks with the heftiest dividend yields regardless of the historical record of distributions. These funds may be more appealing to those with an emphasis on maximizing current returns and less concerned about the consistency with which a firm has made payouts over the years. These ETFs include:

  • Global X SuperDividend ETF (SDIV): This ETF focuses on global stocks with high dividend yields, seeking to replicate an equal-weighted index that consists of 100 individual securities from more than a dozen countries.
  • Guggenheim ABC High Dividend ETF (ABCS): This ETF offers exposure to high-yielding securities from three major commodity-intensive economies; the underlying index consists of the ten highest yielding stocks from Australia, Brazil, and Canada.
  • SPDR S&P Dividend ETF (SDY): This ETF includes the 60 highest dividend yielding constituents of the S&P Composite 1500 that have increased dividends for at least 25 consecutive yields. That combination of consistency and attractiveness of current returns represents somewhat of a hybrid approach.

Another interesting “hybrid” option is the PowerShares High Yield Equity Dividend Achievers Portfolio (PEY). This ETF is linked to an index that includes 50 stocks, selected “principally on the basis of dividend yield and consistent growth in dividends.” That translates into an underlying portfolio that includes both well-known blue chip stocks as well as smaller companies that offer substantial distributions [see PEY holdings].

Dividend ETF Advice

When looking for ETFs that jive with a dividend-focused strategy, it’s important for investors to understand the potential ramifications of prioritizing consistency of returns or magnitude of returns in their approach. The steadiest dividend payers aren’t necessarily the largest dividend payers, and vice versa. Fortunately, there are a lot of options out there offering unique types of exposure; the challenge is finding a methodology that is consistent with a given set of return objectives and risk constraints.

Disclosure: No positions at time of writing.