Dividend ETFs: Three Models, Eight Options, Two Standouts (PID, SDY, DVY)

A recent article in BusinessWeek, One-Stop Dividend Shopping by Joseph Lisanti, reviews the major ETF indexes in this sector.

The indexes that underlie the eight dividend ETF currently trading represent a movement away from the idea of indexes as passively replicating the underlying market. Instead, newer indexes are being designed to have certain investment attributes as the result of applying quantitative screens to the investment universe.

As of May 2006, there are basically three models for dividend indexes. The most popular (in terms of ETF assets) is Dow Jones's DJ Select index. The developers of the Dow Jones Index sought to implement their understanding of the thinking process of dividend investors. [ETF that tracks this index: (DVY)]

The Mergent/S&P indexes used by Powershares, State Street and Vanguard are based on selecting companies with a history of raising dividends each year. [ETFs that track this index, with some important variations: (PFM), (PHJ), (PEY), (VIG), (PID), (SDY)]

The Morningstar indexes use a method with a certain theoretical attraction to it. The Morningstar indexes weight companies on the amount of cash they pay out as dividends -- rather then yield or the size of the dividend. If you owned the Morningstar Dividend Composite Index you would own each US company in proportion to its contribution to the pie of all dividends paid by companies in the index. [ETF that tracks this: (FDL)]

The Dow Jones, Morningstar, and the customized Mergent/Vanguard indexes all use some type of quality screen. Each of these indexes requires dividend growth over a five year period along with a screen for the sustainability of dividend payouts. Because these indexes are not pure market cap weighted indexes, they are "synthetic" rather than natural representations of underlying investment universe.

Each of the dividend ETFs represents an idealized dividend paying stock that is the sum of all the enterprises in the index. Viewed from that perspective, the most interesting ETFs are (PID) and (SDY). The Morningstar ETF profile on PowerShares International Dividend Achievers shows that it is most concentrated in the financial services and manufacturing sectors. It is the only foreign value ETF other than (EFV). The SPDR Dividend ETF (SDY) is cross section of established blue chip companies across all economic sectors. Because the S&P Dividend Aristocrats consist only of companies that have raise dividends for at least 25 years, the relatively young technology sector is under represented.

Chart from BusinessWeek: