- Dividend ETFs focused on large-cap, U.S. based stocks have had excellent performance over multiple time frames.
- ETFs focused on dividend “aristocrats” have consistently been among the top performers.
- Until recently, dividend ETFs with international and small-cap portfolios have lagged their peers.
As a retiree seeking income, I love dividends and buying a dividend Exchange Traded Fund (ETF) is a convenient way to purchase a basket of dividend paying stocks. In recent years, the number of these ETFs has exploded to more than 75 funds. With this plethora of funds, the question is: which are the "best" funds to purchase? There are many ways to define "best." Some investors may use total return as a metric, but as a retiree, risk is as important to me as return. Therefore, I define "best" as the fund that provides the most reward for a given level of risk and I measure risk by the volatility. Please note that I am not advocating that this is the way everyone should define "best"; I am just saying that this is the definition that works for me.
I wanted to analyze performance over a complete market cycle, so I restricted my analysis to funds that were launched prior to October 2007 (the start of the bear market). I also required at least a moderate liquidity, with an average volume of at least 100,000 shares trading each day. The following 12 ETFs were the only funds that met my selection criteria.
Vanguard Dividend Appreciation ETF (NYSEARCA:VIG). This ETF holds firms that have increased their dividend for 10 consecutive years. Stocks with long histories of dividend increases are often referred to as dividend "aristocrats". In addition, the fund has a proprietary screen that tries to weed out firms that may cut dividends in the future. This is one of the largest dividend ETFs with over $20 billion in assets. The fund holds 164 stocks, with industrials making up the largest segment (24%) followed by consumer goods (19%). This fund has an expense ratio of 0.10% and a yield of 2.1%.
Vanguard High Dividend Yield ETF (NYSEARCA:VYM). This ETF selects the large-cap stocks that have the highest forecasted yields and weighs them by market cap. By using forecasted yield rather than current yield, the fund tries to avoid stocks where the price has been beaten down so that the yield is artificially high. The fund holds 391 stocks, primarily from the technology (16%), consumer goods (13%) and financials (13%) sectors. The fund has an expense ratio of 0.10% and yields 2.7%.
iShares Select Dividend ETF (NYSEARCA:DVY). This ETF uses a deep value approach to selecting 100 of the top dividend payers for its portfolio. The fund also uses proprietary screens to exclude companies that might cut dividends. The portfolio leans more toward mid-cap companies with utilities being the largest portion of the portfolio (34%) followed by consumer goods (16%). DVY is one of the largest dividend ETFs with over $14 billion in assets. It has an expense ratio of 0.40% and a yield of 3%.
iShares International Select Dividend ETF (NYSEARCA:IDV). This ETF holds a basket of 100 high yielding stocks domiciled in the Europe, Pacific, Asia, and Canada (EPAC) regions. The fund uses a number of screens based on dividend yield, growth rate, and payout ratios. Australian companies compose 21% of the portfolio with an additional 13% from the United Kingdom, and 11% from France. The fund has an expense ratio of 0.5% and has a yield of 4.6%.
SPDR Dividend ETF (NYSEARCA:SDY). This ETF requires the stocks in its portfolio to have raised dividends for the last 20 consecutive years and then weighs these stocks by their dividend yield. The companies that satisfy these stringent selection requirements are generally firms that place a high priority on dividend payments and have the financial strength to consistently raise dividends. The fund has 97 holdings, primarily from the financial (22%), consumer staples (17%), and industrials (13%) sectors. The fund has an expense ratio of 0.35% and has a yield of 2.2%.
WisdomTree Emerging Markets Equity Income ETF (NYSEARCA:DEM). This ETF uses rule-based selection criteria to build a portfolio of emerging market stocks that have high dividends and relatively low volatility. The fund has 370 holdings from 17 countries. Russian companies comprise 20% of the portfolio followed by China (17%), Taiwan (14%), and Brazil (12%). The fund has an expense ratio of 0.6% and a yield of 4.2%.
WisdomTree Emerging Markets SmallCap Dividend ETF (NYSEARCA:DGS). This ETF focuses on small-cap emerging market companies that pay relatively high dividends. The holdings are weighted by dividend yield. By investing in small-caps, this fund attempts to capture both growth potential while still providing an above average yield of 3.4%. The portfolio includes 600 companies from 17 countries. Taiwan companies make up 28% of the holdings followed by South Korea (10%), Malaysia (10%), and Thailand (9%). The expense ratio is 0.6%.
WisdomTree LargeCap Dividend ETF (NYSEARCA:DLN). This ETF focuses on large-cap stocks from the United States. The fund has 300 holdings that are weighted based on dividends. The largest portfolio components are from the information technology sector (16%) followed by consumer staples (15%), financials (14%), and health care (12%). The fund has an expense ratio of 0.3% and has a yield of 2.3%.
WisdomTree Europe SmallCap Dividend ETF (NYSEARCA:DFE). This ETF focuses on small-cap stocks domiciled in Europe. The fund has 240 holdings that are weighted by dividends. Stocks from the United Kingdom make up 25% of the fund followed by Sweden at 14%, Italy at 14%, and Germany at 10%. The industrial sector is the largest component of the portfolio, coming in at 16%, followed by financials at 17%, consumer discretionary at 16%, and information technology at 16%. The fund has an expense ratio of 0.6% and yields 2.2%.
PowerShares International Dividend Achievers Portfolio ETF (NYSEARCA:PID). This ETF invests in companies that have increased their dividend over the past 5 consecutive years and then weighs the portfolio based on dividend yield. The fund holds 69 securities with the largest portion (21%) from Canada. Other major countries that make up the portfolio include United Kingdom (15%), Bermuda (13%), Marshall Islands (11%), and Switzerland (6%). The largest sector allocation is to energy (22%) followed by financials (14%), health care (10%), and industrials (10%). The fund has an expense ratio of 0.6% and has a yield of 3.4%.
PowerShares High Yield Equity Dividend Achievers Portfolio ETF (NYSEARCA:PEY). This ETF consists of 50 stocks selected on the basis of dividend yield and growth of dividends. The primary sectors of the portfolio are utilities (25%), consumer staples (19%) and financials (18%). The fund has an expense ratio of 0.6% and a yield of 3.3%.
First Trust Morningstar Dividend Leaders Index ETF (NYSEARCA:FDL). This ETF has a portfolio of 100 stocks, selected by using a proprietary multi-step screening process based on dividend yield and other factors. The components of the portfolio are weighted by a formula that takes into account float and dividends. The top sectors in the portfolio are utilities (26%), telecommunications (22%), energy (15%), and health care (10%). The fund has an expense ratio of 0.5% and a yield of 3%.
For reference, I also included the following ETF in the analysis:
SPDR S&P 500 (SPY). This ETF tracks the S&P 500 index and has an ultra-low expense ratio of 0.09%. It yields 1.8%. SPY was used to compare the dividend focused funds to the broad stock market.
To assess the dividend funds over a complete bear-bull market cycle, I plotted the annualized rate of return in excess of the risk free rate (called Excess Mu in the charts) versus the volatility of each of the ETFs from October 12, 2007 (the market high before the collapse) until today. The Smartfolio 3 program was used to generate the images below, including the plot that is shown in Figure 1.
Figure 1. Risk versus reward over the bear-bull cycle.
The plot illustrates that the ETFs have booked a wide range of returns and volatilities since 2007. To better assess the relative performance of these funds, I calculated the Sharpe Ratio. The Sharpe Ratio is a metric, developed by Nobel laureate William Sharpe, that measures risk-adjusted performance. It is calculated as the ratio of excess return over volatility. This reward-to-risk ratio (assuming that risk is measured by volatility) is a good way to compare peers to assess if higher returns are due to superior investment performance or from taking additional risk. In Figure 1, I plotted a red line that represents the Sharpe Ratio associated with SPY. If an asset is above the line, it has a higher Sharpe Ratio than SPY. Conversely, if an asset is below the line, the reward-to-risk is worse than SPY.
Some interesting observations are evident from the figure.
- With the exception of VIG, VYM, and DLN, the dividend funds exhibited a larger volatility than the S&P 500. This was unexpected since dividend stocks are usually thought to reduce volatility.
- Three of the dividend ETFs outperformed the S&P 500 on both an absolute and risk-adjusted basis. Note that the best performer, SDY, had a portfolio of stocks that had paid dividends for the past 20 consecutive years. The next best performer, VIG, had a portfolio of stocks that had paid dividends for the past 10 consecutive year. It is thus apparent that these "dividend aristocrats" provided an excellent total return as well as generated income. This was surprising since dividend stocks are typically viewed as providing less total return than the general stock market.
- Three other ETFs (DLN, DVY, and FDL) have risk-adjusted performance similar to the S&P 500.
- International and small-cap dividend ETFs lagged the large-cap United State based funds. PID was the worst performer even though it selected international stocks with a 5-year history of consecutive dividend growth.
Since all the funds being analyzed were associated with dividend paying stocks, I wanted to see if you received any diversification by investing in multiple offerings. To be "diversified," you want to choose assets such that when some assets are down, others are up. In mathematical terms, you want to select assets that are uncorrelated (or at least not highly correlated) with each other. I calculated the pair-wise correlations associated with the funds. I also added SPY to assess the correlation of the funds with the S&P 500. As you might expect, all the funds were moderately to highly correlated among themselves and with the S&P 500. The small-cap and international funds exhibited the lowest corrections, but these were still above 60%. This suggests that you do not receive significant diversification benefits by investing in more than one or two of these funds.
Figure 2 Correlation matrix over the bear-bull cycle.
Next, I wanted to assess if the performance of these funds changed significantly in recent times when the S&P 500 was experiencing a powerful bull market. I re-ran the analysis over the past 3 years from July 2011 to July 2014. The results are shown in Figure 3 and what a difference a few years made! With the exception of the international and small-cap dividend funds (PID, IDV, DFE, DGS, and DEM), all the funds booked excellent performance, similar to the S&P 500. In fact, 6 of the ETFs had risk-adjusted performance slightly better than SPY and these 6 funds also exhibited less volatility than the S&P 500.
Figure 3. Risk versus reward over the past 3 years.
Finally, I wanted to see how these funds have performed over the past 12 months. The results are shown in Figure 4. During this period, most of the dividend ETFs were tightly bunched around the performance of the S&P 500. Again there were a couple of laggards (DEM, DGS), both associated with emerging markets. Many of the funds that were lagging over previous periods made a comeback during the past 12 months. In particular, IDV and DFE went from laggard to leaders! This was likely due to the performance of the European markets. The six previous leaders (SDY, VIG, VYM, DVY, DLN, and FDL) continued to have good risk-adjusted performances.
Figure 4. Risk versus reward over the past 12 months.
Debunking a myth
There is a lot to recommend companies that pay dividends. Dividend payers are typically thought of as stodgy companies like utilities that are more like the tortoise than the hare. However, my analysis has debunked this myth, showing that dividend paying funds have stood shoulder to shoulder with the S&P 500 in terms of risk-adjusted performance. No one knows what the future will hold but if you are an income investor, you should give these ETFs serious consideration. Of the many candidates to choose from, I like SDY, VYM, and DVY the best.