Thoughts On Dividend ETFs

March 26, 2012

This morning, I got into an argument with our managing editor, Olly Ludwig, about dividend ETFs.

Olly thinks that dividend ETFs may potentially be misleading investors, since they tend to be underweight areas like technology and energy, making their portfolios less diversified.

I couldn’t disagree more.

First of all, dividend ETFs make no claims to be broad market ETFs. They are, instead, focused on historically high-dividend-paying stocks.

These aren’t tiny portfolios, either. The Vanguard High Dividend Yield ETF (NYSEArca: VYM) holds 439 securities and the WisdomTree Equity Income ETF (NYSEArca: DHS) holds 347. The number of holdings obviously doesn’t tell the whole story, but with the top holding coming in at 6.5 percent for VYM and 7.8 percent for DHS, it’s hard to argue that these are highly concentrated funds.

It’s probably fair to say that if you’re interested in technology companies, a dividend ETF in isolation might not be the right ETF for you.

VYM has a higher concentration of technology companies than any of its peers, but still comes in with a mere 8.3 percent—less than half of SPY’s 18.4 percent allocation to tech.

On the low side, Russell’s new ETFs—the Russell High Dividend Yield ETF (NYSEArca: HDIV) and the Russell Small Cap High Dividend Yield ETF (NYSEArca: DIVS)—allocate 1 percent and 0.6 percent of their portfolios, respectively, to technology.

But I don’t generally think of technology companies when I think of high dividends. If you’re interested in technology, there are 10 ETFs that focus strictly on U.S. technology companies—you’ll have better luck finding what you want there.

According to economic theory, it only makes sense to pay dividends if a company can’t figure out anything better to do with its cash. Fast-growing technology companies, thus, are more likely to invest their excess cash in more growth opportunities.

Apple made a big splash when it announced its $2.65 quarterly dividend, but with a handle close to $600, that’s a 1.8 percent dividend yield. In comparison, companies like AT&T and General Electric have historical dividend yields of 5.6 percent and 3.4 percent, respectively.

Although Apple’s dividend is certainly high enough to warrant its inclusion in dividend-focused funds, it likely won’t appear in any for at least a year. That’s because most dividend indexes require at least a year of consistent dividend payment, and some require an even longer history.

We can look at the historical dividend yields of the sector SPDR funds to further make my point:

Historical Dividend Yields of Sectors SPDR Funds







Personally, I’m not sure I would trust a technology-heavy fund that claimed to be focused on high dividends. Or at least, I wouldn’t expect to see a particularly high dividend yield.

There are market-cap-weighted dividend ETFs for investors who want dividend exposure that’s closer to the market—VYM is market cap weighted, as are offerings from Schwab (NYSEArca: SCHD) and PowerShares (NYSEArca: PFM).

Of course, for those who are really focused on maximizing their dividend income, there are plenty of options that weight their holdings based on cash dividends as well, like DHS.

But no matter your choice, don’t expect to get the market, because you won’t.

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