Dividend ETF With Growth Tilt Makes A Comeback

Includes: DVY, VIG
by: Tom Lydon

The S&P 500 keeps rising and dividend exchange traded fund investors are feeling more confident as they start to favor growth over yield.

Over the past month, total returns of the two most popular dividend funds, the growth-minded Vanguard Dividend Appreciation ETF (NYSEARCA:VIG) and the value-oriented iShares Dow Jones Select Dividend ETF (NYSEARCA:DVY), have begun showing similar performances.

Over the past three months, VIG has lagged behind DVY by 1.8 percentage points, and over the past three years, the performance gap was 2.4 percentage points.

"Investors have been driving up valuations for dividend ETFs with the highest payouts, ignoring longer-term growth patterns," Carl Camp, president at Eclectic Associates, said in a Wall Street Journal article.

"Normally, firms with lower payout ratios and higher forecasted growth rates trade at premium valuations," according to Michael Rawson, a Morningstar analyst. "But investors have been turning those historic relationships on their ear in their quest for higher yields."

However, there is a growing shift in dividend ETFs.

"We've seen the signs of a change in market leadership and that has filtered through to dividend funds less tilted to defensive sectors like utilities," Doug Flynn, co-founder of Flynn Zito Capital Management, said in the article.

Rawson points out that the Vanguard dividend ETF emphasizes "companies with a higher quality of earnings," which makes it tilt toward growth-styled stocks.

VIG has a 1.2% allocation to utilities, whereas utilities is the largest sector weighting in DVY at 30.2%.

"We're telling investors to put new money into more-diversified dividend funds," Mr. Flynn said in the article. "The market's sweet spot for dividend-paying stocks seems to be shifting in the direction of funds with lower yields but better growth potential."

Max Chen contributed to this article.

Full disclosure: Tom Lydon's clients own DVY.

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