‘Aristocrat' Dividend ETF’s Novel Approach Working

Methodology mitigates sector tilts seen in other dividend funds.

Philip Van Doorn, an investing columnist for MarketWatch, started his piece this week with a great line: “Boards of directors that consistently reward investors with higher dividends don’t get enough praise.”

Why? Because, as his piece detailed, dividend “aristocrat” stocks—those that have increased their dividend payments for the past 25 years and are included in the S&P 500 Dividend Aristocrats Index—have delivered not only income but growth to investors. They also consistently deliver more in total returns than the S&P 500.

Different Dividend ETF Composition

For ETF investors, those stocks can be accessed in a single portfolio through the ProShares S&P 500 Dividend Aristocrats ETF (NOBL). The ETF is today the 11^th-largest dividend ETF in the market, with $2.48 billion in total assets.

But NOBL, while a high-dividend play, isn’t exactly like some of the most popular ETFs in this segment, funds like the $16.3 billion iShares Select Dividend ETF (DVY)—the largest high-dividend ETF on the market today.

The crucial difference is in the stock selection process underlying each fund. Yes, both look for stocks that have a solid track record of increasing dividends, but a so-called traditional high-dividend ETF such as DVY also selects and weights securities based on highest dividends.

Portfolio Tilts

Specifically, in DVY’s case—which we are using as an example of a more traditional approach to high-dividend ETF investing—the fund looks for a five-year history of dividends.

The fund is also dividend-weighted, picking some 100 stocks based on dividend yield from a broad market-cap universe and weighting them based on dividends, from highest to lowest.

The methodology often translates into a portfolio that tilts toward equity sectors that are known for high dividends, such as utilities and financials. That leads to concentration not only at the sector level but at the security level, as the fund allocates most heavily to higher-yielding stocks.

The 10 biggest holdings represent more than 20% of the portfolio.

Equal-Weighted Option

By contrast, NOBL offers equal-weighted access to S&P 500 stocks that have increased their dividends for the past 25 consecutive years.

Here, the track record requirement is longer, and each security is assigned roughly the same weighting in the portfolio to increase diversification. What’s more, the fund doesn’t screen for highest-yielding stocks only, avoiding some of the traditional sector tilts seen in funds like DVY.

In fact, while today roughly 30% of DVY is tied to utilities, and 14% is linked to financials, NOBL’s biggest sector allocation is consumer staples, at about 26%. Utilities are the smallest sector weighting—under 2%.

What NOBL gives up for the sake of diversification is yield. DVY is all about finding the highest-dividend-paying stocks within the broad stock market. NOBL has a current 30-day yield of 2.06%, which compares to 3.19% for DVY.

But both these high-dividend ETFs have in common a track record of outperformance relative to the S&P 500. Consider the year-to-date chart below—DVY has delivered roughly double the returns of the SPDR S&P 500 (SPY), while NOBL has outperformed by some 5 percentage points: 

Clearly, DVY is the best performing of the trio year-to-date—it’s also the largest ETF in the high-dividend ETF segment and it’s only slightly more expensive than NOBL, with an expense ratio of 0.39% versus NOBL’s 0.35% price tag.

These two ETFs are merely a sampling of a segment populated by more than 100 funds today. (You can see a comprehensive list here.) But the subtle distinction between these methodologies, and the ensuing sector tilts and exposure differences each portfolio offers in the name of high-dividend investing, is notable.

Both portfolios offer income and growth, and deliver outperformance with lower volatility than a simple investment in SPY, as the three-year chart below shows, but each high-dividend ETF goes about it in a different way.

Charts courtesy of StockCharts.com

The comparison between DVY’s investor-favorite approach to the highest-dividend-paying stocks and NOBL’s focus on the equal-weighted and longer track record of the dividend aristocrats is a good reminder of the importance of looking under the hood before picking the right ETF for your needs.

Contact Cinthia Murphy at [email protected].