Sectorology: ETFs and Dividend Yields

by: Roger Nusbaum

Yesterday a reader left a comment asking about dividends from the new PowerShares domestic small cap sector funds. He said he needs more in the way of dividends because he is retired. I gave a quick answer that I want to expand upon today.

So it seems from the question that the reader uses ETFs and either does or is willing to build a portfolio at the sector level. This brings up one of the drawbacks of ETFs that I first brought up before WisdomTree existed, which is that it is very difficult to build an ETF portfolio that emphasizes dividend yield. Even with WisdomTree it can be difficult to get a 3% yield, especially given that the firm closed most of its sector funds.

You can go to the sites for the various providers and see what the yield has been, and Yahoo Finance had gotten better at correctly reflecting the yield based on the trailing 12 months. Do keep in mind that yield going forward will not be the same as the trailing yield. The trailing yield is best thought of as an indication.

There are certain sectors that typically pay higher dividends than the 2% we've come to expect from the S&P 500. The financial sector is one such sector, although not so much in the last couple of years. Per the SPDR website the Financial Sector SPDR (NYSEARCA:XLF) yields 1.17% and the International Financial SPDR (NYSEARCA:IPF) yields 1.30%.

Some specialty funds might offer a little better yield. The iShares Singapore Fund (NYSEARCA:EWS) is about 50% financials and yields 2.66%. The WisdomTree Pacific Ex-Japan (DNH) has a similar weighting to financials, is very heavy in Australia and yields 3.45% which is a little better still--some clients own DNH. Even if you put 16% of your portfolio into DNH (about the weight of the financial sector in the S&P 500) there are several sectors that will not provide a lot of yield, at least not at the fund level; sectors like discretionary and tech which are pretty big and some of the high yielders have 3% weights in the index like telecom and utilities making getting a 3% yield for the entire portfolio very difficult. Putting 10% into a sector that only comprises 3% of the index is a pretty big bet and would fall into the realm of yield chasing, in my opinion.

At this point it makes sense to entertain branching out into individual stocks that might yield a little more. With a hat tip to Top Foreign Stocks, CorpBanca (BCA) from Chile yields 6.70% and Banco De Chile (NYSE:BCH) yields 6.30% (to be clear I own a different Chilean bank and am not recommending either of these they are just example) . Something like a quarter of a financial sector allocation into a well researched high yielding stock is obviously an easy way to lift the yield of the entire portfolio while still allowing for exposure to some more growthy holdings.

This can be repeated in most sectors--that is combining something with a very high yield like BCA, something with a slightly above market yield like DNH and depending on the sector something like a specialty ETF where a small yield doesn't have to be a reason to avoid or something with no yield in a sector that typically doesn't pay dividends.

If you think about there being ten sectors, having just one holding for telecom, utilities and materials (high yielding or not) because they only have 3% weights in the index that leaves seven sectors. If each of those seven have three holdings that makes 24 for the entire portfolio with at most seven individual stocks to keep tabs on.

For some folks who have not bought individual stocks before maybe this puts a different perspective on using them in conjunction with funds to build a portfolio. For some other folks, picking one breakfast cereal over another amounts to speculation and this would never fly.