Dividend ETFs — Valuable Portfolio Components

Roger Nusbaum submits: A reader left a great question that I will try to answer with this post. The comment was partly in response to a statement I made about not getting too carried away with success of the dividend ETFs of late. They have done well because large cap value has done well.

To be clear I am generally a fan of dividend ETFs, but I do not think they will be up if large cap value goes down. The comment from the reader says that SPDR Dividend Arisocrats ETF (SDY) is superior. While that may be, if the iShares Russell 1000 Value Index ETF (IWD), the reader's proxy for large cap value, goes down by 10%, SDY will not be up 5%. According to PortfolioScience, SDY and IWD have a .897 correlation.

If I understood correctly the reader looked at a chart similar to the one I have placed here:

He looked at SDY's ratio to IWD. Since iShares Dow Jones Select Dividend (DVY) has been around longer, I used that one instead. I think this is valid because SDY and DVY have 0.92 correlation, and the returns of each have been very similar since SDY's inception last November. The chart covers two years and it shows DVY lagging IWD. Since May, the nod goes to DVY.

The second chart is the more typical comparison. It covers two years and shows IWD pulling away by a mile:

For the trailing twelve months IWD is up 13% and DVY is up 6%. The dividend advantage for DVY is only about 150 basis points.

For the last three months the two are dead-even, and SDY also had the same return for the last three months.

The reader then goes on to ask how I would allocate the large cap portion of the portfolio for what he calls moderate growth using ETFs.

I think the reader is looking for a simple two or three ETF suggestion. This is not easy for me to answer as I don't really use cap-size ETFs in portfolio construction.

Where the portfolio is large enough to fully diversify, I think I would rather add yield from other places, like maybe from foreign exposure. I will say that the WisdomTree domestic ETFs, in the context of this conversation, look very interesting. The Domestic High-Yielding Fund (DHS) yields 3.96% and it is heavily weighted in large cap stocks. There is no real track record yet to speak of for the fund. I have no doubt the back testing of the index looks great, but going on back testing alone is a tough one for me for something that I view as being very broad based.

Another point relative to the original comment is that there seems to be no mention of large cap growth. Ignoring growth is a bad idea. I think ignoring anything is a bad idea. I am not saying the reader is ignoring growth but there is no mention of it in the question.

I do own DVY in some accounts where full diverisification, the way I think of it, is not an option.