Reasons To Still Be Long On DVY

| About: iShares Select (DVY)

The purpose of this article is to determine the attractiveness of iShares Dow Jones Select Dividend (NYSEARCA:DVY) as an investment option. DVY has been a strong holding of mine since the start of the year, and has performed consistently well, along with the broader market. With the indexes reaching new highs, it is time to revisit this investment to see where the ETF may be headed from here. I will review DVY's recent performance, current holdings and weightings, and trends in the market to determine if it makes sense to hold on to this investment going in to 2014.

While DVY generally moves in close comparison to the Dow Jones Index, it is not an ETF that tracks the index specifically. Rather, DVY consists of 100 of the highest dividend-yielding securities (excluding real estate investment trusts (REITs) in the U.S. This has been a lucrative investment theme over the past 12-18 months, as investors have sought the relative safety of large-cap U.S. stocks and have sought income with the yields they produce, since Treasury bills have been at historic lows. At this time of writing, DVY is currently trading $70.10/share, with a quarterly dividend of $.54/share, which translates to an annual yield 3.1%. Year-to-date, the fund is up over 22%, excluding dividends, and over the past 52 weeks, the fund is up over 25%, also excluding dividends. DVY has actually outperformed the Dow Jones average by a small amount, and has paid reliable dividends to investors, prompting a steady amount of cash inflows in to the fund throughout the year.

By looking at the stocks that make up DVY, it should be no surprise as to why the fund has performed so strongly. Here is a list of the top 10 holdings (as of 11/8/2013):

Name % of Fund
Total 21.79

I personally like that the fund has no more than 4% of any one stock in its holdings and with 100 securities (plus some cash), the fund is properly diversified.

Given the fund's strong performance, it is natural to wonder whether the fund can continue its momentum, or whether it makes sense to take some profit and consider other investment options. There are a few reasons why I am going to stay long DVY, given that I expect the market to continue trending higher over the next 6-12 months.

One, I do not believe the investment theme of looking for safety is going away any time soon. Yes, bond rates may rise in the near future, but I personally do not believe that is going to happen at the December Fed meeting as some analysts predict. Unemployment is still above 7%, and the Fed seems committed to seeing that number decrease further before withdrawing stimulus. With that scenario, bond rates will stay low, and dividend yields will continue to be the top place investors will look for safe income.

Two, the industries that make up DVY scream safety. While high yields are important, reliability matters more. DVY is made up of companies that have both high yields and a commitment to increasing payouts over time. The top three holdings are Utilities, Industrials, and Consumer goods. These are sectors that do well in good times and bad, so if the market does take a dive, expect these sectors to outperform and also to have the cash flow to maintain their payouts.

Third, I expect dividends as a whole to rise in 2014, providing an important catalyst for the stock. The Wall Street Journal recently did a study that displayed the massive amounts of cash U.S. companies now hold, and that many are using it to increase dividends.

The companies surveyed paid out about $300 billion in dividends in 2012, up 16% from 2011 and up about 49% from three years ago. Again, I expect this trend to continue, as companies have been actively trying to return more money to shareholders. As dividend payouts rise, so does the yield, providing extra protection against any downside risk. DVY will be a direct beneficiary of this policy, since it holds many of the very same cash-rich companies discussed in this article in its portfolio.

Lastly, investors are also sitting on large amounts of a cash. Wealthy families have about 39 percent of their assets in cash, according to a recent poll of more than 50 large family office representatives from 20 countries conducted by Citi Private Bank. This to me means a few things. Major investors are still under-invested. If these investors decide to enter the market, the results could only be positive for equities. Additionally, I believe that when those who are under-invested re-enter, they will pursue a dividend seeking approach which caters exactly to those already committed to funds like DVY. I feel that if investors are cautious enough to still be sitting in cash, it is unlikely they will dive back in to the market with risky or alternative investments. Thinking rationally, they will tread back in lightly, probably looking for steady income in bonds and dividends, giving further upside to funds that provide exposure to the highest-yielding companies, such as DVY.

Bottom line: The market has had a tremendous run. DVY has performed strongly during it, but investors have made money in almost every asset class since the start of the year, so this alone does not differentiate DVY from other opportunities. However, the fact that DVY has outperformed the broader market, while also sporting a lower beta (.95), has proven it to be a reliable investment to those who seek reasonable returns with reasonable implied safety. Of course, there are risks to such a strategy. One, the market could trend significantly higher and leave the steadier companies that make up DVY in the dust. Or, the Fed could significantly cut back on quantitative easing, pushing bond rates higher and sending income investors out of DVY and in to T-bills. However, based on the above reasons discussed, I still find the upside potential in DVY very attractive and would recommend investors take a serious look in to this fund.

Disclosure: I am long DVY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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