In turbulent times, the conservative investor tends to turn to a safe zone, in particularly, dividend-focused ETFs.

Dividend-focused ETFs are great in that they enable your money to work for you on its own while enabling investors to gain access to various markets and sectors. One may wonder how to choose a stable dividend ETF. After all, at the end of 2008 there were 14 different such ETFs to choose from.

Hickey and Walters (Bespoke) submit: With the recent cut in the Discount Rate, there has been a lot of focus on dividend paying stocks that could move higher as investors search for yield that has been lost in the fixed income markets. For investors that want to spread risk by investing in a basket of stocks instead of specific companies, dividend ETFs might be attractive.

Below we highlight a list of dividend ETFs across a variety of styles and regions. We have sorted the ETFs by their percentage change since the 7/19 market top.

There were 27 common positions shown in the table below.

DVY is based on a Dow Jones dividend index. SDY is based on the S&P Dividend Aristocrats index. FVD is based on a Value Line dividend index. PEY is based on a Mergent dividend index. [click to enlarge]

To begin this topic, let’s see what dividend is. According to Investopedia, dividend is

Distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. The dividend is most often quoted in terms of the dollar amount each share receives (i.e. dividends per share or DPS). It can also be quoted in terms of a percent of the current market price, referred to as dividend yield.

Hickey and Walters (Bespoke) submit: With nearly 600 US ETFs, it is often difficult for investors to navigate through the maze and find the specific ones they are looking for. Bespoke is currently working on a project to simplify this process for investors, so if you are an investor that uses ETFs, be sure to check back with us in the future.

Below we highlight a list of 26 dividend ETFs for investors looking for yield. We also provide the average yield of the stocks that make up the ETF.

• unusual bonds with high yields.
• certain fixed income closed end funds at a discount.
• dividend paying stocks, and occasionally (ugh) preferred stocks.
• non- or low dividend paying stocks that fit my eight rules, and sell out-of-the-money calls against them.
• lever the fund by borrowing at LIBOR.
• Use my mean reverting REIT, utility, LP strategy. Backtests have it generating a 20% return annually, and I haven’t tweaked it.

The thing is, though, yield is a conceit. People like to think that they are merely scraping the income off of the portfolio, when in many cases, they are truly consuming capital, but the accounting doesn’t make it look that way. Think of a high yield fund with a single-B average credit quality. During good times, the full yield, and maybe a tiny amount of capital gains comes into income. During bad times, the yield shrinks, and capital losses get passed through. Over a full cycle, the NAV of a high yield fund shrinks.

So… is it true?

Unfortunately, it’s still too early to say. Most of these funds have launched within the past year, and you shouldn’t stake too much on a one-year track record. (The backtested data should be largely ignored, as it is far too easy to backtest your way to strong results.)

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Seeing The World
One-stop shopping. Or, at least, two-stop shopping. That’s the idea behind the newly launch global (ex-U.S.) exchange-traded fund [ETF] from State Street Global Advisors [SSgA].

My take is that PowerShares is letting people choose their alpha. You can get it from the Intellidex black box, or from the fundamental weighting hypothesis.

For more, see our initial coverage here.

DVY and PEY both have criteria for selection that will rule out inclusion of many types of high-yielding stocks, and the rationale is typically made that the screening criteria for inclusion are intended to limit risk, other wise known as portfolio volatility. This idea makes some sense because many ‘income investors’ are fairly risk averse. In standard financial practice, risk is measured by two variables: Beta and Standard Deviation [SD] of returns. If we were to compare dividend-focused ETF’s to a portfolio of high-dividend stocks, we might want to adjust the stock portfolio to that it’s Beta and SD over an extended period of time was very close to the values for the dividend-focused ETF’s. In this way, we would have compensated for risk differences between the basket of stocks and the ETF’s.

If the alternative stock portfolio shows better returns with risk less than or equal to the ETF’s, it would be hard to argue that the stock portfolio as a whole is in any way more risky than the ETF’s. In the previous paper, I looked at comparing portfolios with equivalent risk levels but the comparisons were limited by the very short available histories for the ETF’s. In this analysis, I have found an effective way to overcome this issue.

Peters is suggesting that dividends will likely go up in the future because of the income demands by Boomers and because many firms and the U.S. economy as a whole is more knowledge driven and less capital intensive than it used to be -- not to mention that corporate profits are very high. These are all good points. Further, after a number of years of high earnings, many firms are sitting on considerable amounts of cash that will either be used to fund share buybacks or dividends. These funds could also be deployed, however, to fund internal growth or acquisitions. Further, the incentive structure for executives are often tied to share price performance and paying dividends will reduce the potential for price appreciation. The value of employee stock options is inversely related to dividends.

Purchasing stocks with high dividends relative to stock price has historically been a winning strategy. This is another reason why many investors look for high dividend stocks. It remains to be seen whether high dividend ratios continue to be a good predictor future higher-than-normal returns, but the underlying logic is compelling.

A Set of High Dividend Stocks