Perhaps surprisingly when considering interest rates are rising – usually a negative for high-yield assets – high-dividend stocks and the related exchange traded funds are delivering for investors this year.
Broadly speaking, these ETFs are outperforming the S&P 500. The Franklin U.S. Low Volatility High Dividend Index ETF (LVHD ) is doing so in a dramatic fashion, beating the benchmark domestic equity gauge by more than 1,000 basis points year-to-date.
LVHD’s 2022 performance in 2022, though not perfect, is a prime example of the need for investors to be judicious when evaluating dividend ETFs, particularly those positioned as high payout offerings.
“Dividend-income funds may look appealing to those seeking a stable source of income. Done well, they can deliver on this objective. But there is some nuance to determining what constitutes a good dividend-income index strategy,” noted Morningstar analyst Daniel Sotiroff.
A frequently voiced concern about dividend ETFs is that, at the sector level, these products lean heavily into value equities. Specific to LVHD, the fund is more defensive as highlighted by a more than 58% combined weight to the utilities, consumer staples, and real estate sectors.
In general, those sectors are considered high-dividend destinations. One of the primary rubs with high-payout stocks, regardless of sector, is that some of these names can be vulnerable to negative dividend action. Additionally, some stocks with big payouts can be more volatile than their dividend growth counterparts. Those points underscore the necessity of selectivity with dividend ETFs and the value in the LVHD methodology.
“Changes to dividend payments don’t occur in a vacuum. Stocks with rising dividends are often backed by financially stable companies with strong sales and profit growth that support those higher cash distributions. These profitable firms often trade at higher prices relative to their fundamentals, including dividends, and rarely if ever land in the higher-yielding segment of the market,” added Sotiroff.
While LVHD is positioned as a high dividend and low volatility option – traits the ETF lives up to – many of its holdings have impressive track records of dividend growth. That’s a sign of quality and one confirming LVHD mitigates some of the risks often associated with high-dividend strategies.
“Digging into dividend-income strategies may not always be as straightforward as the cases above. In some instances, strategies may take measures to control risk that look great on paper but don’t live up to their billing,” concluded Sotiroff. “Ultimately, dividend-income funds make a trade-off between yield and dividend sustainability. Most of the time, sustainability declines as yield rises.”
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