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Who ever said exchange-traded funds were simple? The Claymore/Zacks Dividend Rotation ETF began trading this week under the symbol IRO on the American Stock Exchange, and it brings a new level of complexity to dividend ETFs. (You can read the prospectus here.)

The latest offering from Claymore Securities tracks the Zacks Dividend Rotation Index, which is a domestic index designed to maximize dividend income at the lowest possible tax rate.

The index's 100 components are divided into two subindexes of 50 components that are rebalanced monthly on an alternating basis. Stocks that have paid a dividend in the prior 30-day period or that are included in the other subindex are excluded from eligibility during the monthly rebalancing. Eligible stocks are evaluated using a quantitative method designed by Zacks to select stocks with the greatest yield potential; it bases an individual stock's ranking on factors such as its likelihood of paying a dividend in the subsequent 30-day period, payout ratio, yield, liquidity, company growth and relative value. The selected 50 components are then weighted based on yield and liquidity.

In addition to maximizing qualified dividend income [QDI], the index is also designed to select stocks that will outperform other benchmark indexes, including the Dow Jones Select U.S. Dividend Index, specifically. This year, that goal looks to be seriously threatened as the Zacks Dividend Rotation Index was down 6.07% through the third quarter versus a 1.08% rise in the DJ Select Dividend U.S. Index. However, in seven out of the nine years preceding 2007, the Zacks Dividend Rotation Index outperformed the DJ index in backtested data. Over an approximately 10-year period, the Zacks index had an average annual return with reinvested dividends of 15.49% versus 12.45% for the DJ Select Dividend Index.

However, the returns aside, what seems to be the main issue of concern with this index is the potentially massive constituent turnover: Every month, half of the index is eligible for replacement. By contrast, the DJ Select Dividend U.S. Index is reviewed annually.

The DJ Select Dividend U.S. Index also underlies an ETF. The iShares Dow Jones Select Dividend Index Fund (DVY) has been trading since late 2003 and has roughly $7.6 billion in assets. Its expense ratio of 0.40% is cheaper than that of IRO by 20 basis points. (You can read the prospectus here (.pdf).)

As of September 30, the top five components of the Zacks Dividend Rotation Index were Corus Bankshares Inc. (3.74%), IndyMac Bancorp Inc. (2.65%), Oriental Financial Group (2.37%), Alliance Resource Partners LP (2.12%) and Building Materials Holding Corp. (1.84%). Financials had the highest weighting in the index by far, at 51.00% of the index, followed by Consumer Staples at just 8.12% of the index.

Written by Heather Bell

• More on Broad US Dividend ETFs

Source: Claymore Challenges iShares For Dividend ETF Dominance