Dividend ETFs: Too Exposed to Financials

Right up my '70s alley, Blazing Saddles made "We don't need no stinking badges" popular. Yet it was the 1948 film, "The Treasure of Sierra Madre," that started it all. (At last, I can talk about being too young to remember an original!)

With the latest from Citi (C) and B of A (BAC), many people are thinking, "We don't' need no stinking financials." Investors have had it... and who hasn't?! Apparently, writers who lack curiosity... that's who!

The exposure to banks/insurers/financial companies in "Dividend ETFs" have caused them to be among the hardest hit by the current bear. Nevertheless, many bloggers -- and many writers in the business media -- continue to blindly recommend them.

It's not a new phenomenon. It's not a prediction that the worst is over for financial companies. In fact, if it were a prediction, or a "way-to-play" financials, I'd respect that.

Unfortunately, that's not the case. Many of the writers lack a basic knowledge of what lurks inside brand-name "Dividend ETFs." (They simply churn out the same-old story year after year!)

Now, dividends play a huge part in many of the ideas that I discuss. I am constantly addressing ways to get more income from ETFs. Yet even a basic understanding of the global credit crisis should give income-oriented investors pause when they read glowing stories about dividend choices.

Recently, I came across a "puff piece" that talked about the great income from these popular names:

Brand-Name Dividend ETFs
					Annual Yield
SPDR S&P Dividend ETF (SDY)					5.50%
First Trust Morningstar Dividend Leaders (FDL)					5.50%
WisdomTree Total Dividend Fund (DTD)					4.60%

On the surface, any one of these choices should outperform a 10-year U.S Treasury with 1/2 the yield, right? And aren't we in this investing thing for at least 10 years?

Maybe so, but I am not willing to gloss over the huge financial/bank/insurance company exposure of traditional dividend ETFs. The SPDR S&P Dividend ETF (SDY) has 40% exposure to financials and the First Trust Morningstar Dividend Leaders (FDL) has 35%. I might feel a bit better with the WisdomTree Total Dividend Fund (DTD), with 20% financial exposure, but even then?!?!

(click on chart to enlarge)

Let's face facts... most dividend funds fell right in line with the S&P 500 SPDR Trust (SPY). Why would a 40% loss that requires a 67% total return gain to recover be worth the aforementioned yield? Why get a so-called income investment that isn't less volatile or a better performer than the S&P 500 market at large?

A more discerning income investor, then, may wish to see if he/she can sidestep financial companies. I believe that answer... at least when it comes to common stock... is best uncovered in Global Telecom (IXP) and Global Utilities (JXI).

At the time of this writing,Global Telecom (IXP) offers a comparable yield to the traditional dividend ETFs of 5.35%, while Global Utilities (JXI) is serving up an attractive 5.75%. And if you "do" want your financials, you don't need to look any further than the basic benchmarks (e.g., S&P 500, MSCI EAFE, etc.) themselves.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[Vox Rationalis:]

"Why get a so-called income investment that isn't less volatile or a better performer than the S&P 500 market at large?"

Seems to me the question should be the inverse - if your choice is between the market at large and an investment with the same volatility and price performance that pays a higher dividend, why wouldn't you prefer the higher dividend?

Jan 16 08:22 AM

[Steve in TN:]

Currently, I would have to agree with BS Detector (what a name!). Compare the one-year chart of the SP500 with high-dividend ETFs: SDY, PWV, and PFM. Just looking at the chart the SP500 index would not be selected as an investment; this is not even considering the greater annual dividends of the other three ETFs. Until proven otherwise I would stick with the large cap high dividend ETFs over the SP500.

Jan 16 09:32 AM

[JLP:]

Mr. ETF "Expert",

The chart I'm looking at shows SDY down around 30%, while SPY is down over 40%. That's quite a difference.

Also, yield is relative as it depends on WHEN you purchase the asset. Surely SDY is a lot more attractively priced now than it was a year ago.

Jan 16 12:03 PM

[JLP:]

One other thing...

The SPDR website shows a 19.65% allocation to financials, not the 40% you mention.

Jan 16 12:16 PM

[searcher:]

Relatively safe income streams with highly likely price appreciation for a significant total return are on 'going out of business' hedge fund etc. sale. Don't let your 'due diligence' be shorted out by the dangerous environement. Knowledge and fortitude will be rewarded to a greater degree than for well over a generation.

Jan 16 12:25 PM

[Vaun:]

Look at FVD as well. It and SDY are significantly outperforming the market..

Congratulations, you just found the best performing broad based ETFs for the past year... and had the audacity to state the ones recommending them "lack a basic knowledge of what lurks inside brand-name 'Dividend ETFs.'" Really, do some research. You open this article by mentioning C and BAC. You'll notice with a couple clicks that they're not even in the top 10 holdings for either of these dividend funds.

@ JLP - SDY did have a 40% financial allocation... The index would kick out any stocks that faltered on their dividend. If that's right the turnover this year will be substantial. Very interesting.

Now, without analyzing SDY in depth this may be a bit of a jump. But at a glance SDY (and FVD to a lesser extent) are heavily financial and heavily geared towards midcap value. Perhaps the smaller banks are doing well during this mess as people turn away from the megabanks with disgust. Or maybe smaller banks are just run better. Who knows.

Figuring out why these ETFs have outperformed would be a good article. Figuring out why some dividend ETFs have grossly outperformed others would be another good article. Figuring out if SDY has completely overhauled its portfolio due to dividend cuts would be yet another. Considering whether these ETFs will rebound as well as the broader market, a good idea. This article however..... useless if-not-harmful to the average investor.

It should also be noted that IXP and JXI (the author's recommendations) have easily been outperformed by both SDY and FVD over the past year.

Jan 16 01:01 PM

[Vaun:]

Disclosure: I own SDY.

Jan 16 01:07 PM

[JLP:]

Vaun,

What was the dividend amount on SDY for the 4th quarter? I can't find the information anywhere.

Jan 16 01:50 PM

[JLP:]

Vaun,

It may have had a 40% financials exposure but it doesn't now. But, Gary Gordon doesn't mention this.

Jan 16 01:51 PM

[donzelion:]

When no other reliable sources of information about corporate health are available, dividends speak volumes. That's a fairly apt description of emerging markets, so DEM seems like a good choice for uniquely structural reasons (and they have lower financial exposure than other emerging market funds).

In the "highly correlated but better returns" meme, I like Vanguard's VTV v. DTD, or FDL. Not exactly a "dividend ETF" - but a nice dividend.

Jan 16 05:34 PM

[Vox Rationalis:]

BTW, I'm in PGF, which is a dividend fund invested exclusively in preferred shares of financials. Trailing 12 months dividends were 13.86%, which makes it clear that the market is discounting for cuts in preferred dividends in the coming months/years. It will be interesting to see how much that happens.

Meanwhile, when dividends are included, PGF performed about the same as SPY over the last year. To make things simple, I just took the dividends and added them to the share price rather than reinvesting them (which will benefit the PGF in the comparison). SPY: -35.9%, PGF: -34.3%. Of course, ending that period in the mid-September to mid-December timeframe would yield quite a different result. But hey, I didn't pick it!

The real question, however, isn't the past - it's the future. Do you expect the financials to outperform or underperform the market going forward? And in the case of the preferreds, do you think the banks will stop paying dividends on them?

Jan 16 05:45 PM