SDY Can Still Make You Money

| About: SPDR Dividend (SDY)
This article is now exclusive for PRO subscribers.

The purpose of this article is to evaluate the attractiveness of S&P Dividend (NYSEARCA:SDY) as an investment option. This has been a very popular ETF for the past several years as it seeks to closely match the returns and characteristics of the S&P High Yield Dividend Aristocrats Index. This Index is designed to measure the performance of the 60 highest dividend yielding companies that have followed a policy of consistently increasing dividends every year for at least 25 consecutive years. With markets reaching new highs on a daily basis, I am going to re-examine SDY to determine if it makes sense for investors to establish new long positions in this fund or if it is more prudent to take some money off the table.

SDY has rewarded investors since the beginning of 2013, with the fund up over 26% at the time of writing, excluding dividends. SDY currently pays a quarterly dividend of $.40/share which, based on the current market price of $73.30, translates to an annual yield of 2.2%. Thus, SDY has done well, as investors have sought the relative safety of large-cap U.S. stocks and income with the yields they produce, since Treasury bills have been at historic lows. This is a theme I expect to continue going in to 2014, even with the headwinds of an expected market pullback and increasing Treasury yields. For starters, the companies that make up SDY have a proven record of strong performance during good and bad times. Here is a list of the top holdings in the fund, as of 11/27/13:

AT&T Inc. (NYSE:T) 3.01%
HCP Inc. (NYSE:HCP) 2.51%
Consolidated Edison Inc. (NYSE:ED) 2.40%
National Retail Properties Inc. (NYSE:NNN) 2.24%
Kimberly-Clark Corporation (NYSE:KMB) 2.10%
The Clorox Company (NYSE:CLX) 2.10%
AbbVie Inc. (NYSE:ABBV) 2.09%
Sysco Corporation (NYSE:SYY) 2.05%
McDonald's Corporation (NYSE:MCD) 1.91%
Chevron Corporation (NYSE:CVX) 1.88%

Even though SDY is not actively managed, it still has no more than 3% in a particular stock, and it is properly diversified across sectors. Its top four sectors are consumer staples, financials, industrials, and materials, at roughly 20%, 16.7%, 12.5%, and 10.5%, respectively. SDY is also weighted between 9-10% with utilities, health care, and consumer discretionary stocks. Essentially, SDY hits all the major sectors and has exposure to the sectors that typically have steady positive cash flows and reliable dividends, exactly the characteristics that do well when the market pulls back.

Investing in SDY is not without risk. SDY, and similar dividend funds, have outperformed the market indexes because investors have piled enormous amounts of cash in to these popular vehicles. If investors' appetite for risk increases, you could see money flow out of these funds and into riskier areas, such as technology stocks or into emerging markets. Additionally, talk of the Federal Reserve beginning to taper its bond purchase program has become a daily reminder that the cheap money policy will not last forever. In fact a recent article by Bloomberg highlights that the Fed may begin tapering in "the coming months". If this is the case, and interest rates begin to move higher, you may see investors move out of dividend ETFs and into bonds for the higher rates.

However, I feel these risks are overblown. In a recent article of mine in which I discussed DVY, a similar dividend ETF, I highlight how many investors, despite, or perhaps because of, the recent run-up in the market, are sitting on traditionally high amounts of cash. If bond rates do rise, I expect investors to use that excess cash to move into bonds, and not at the expense of their current holdings in dividend stocks. Additionally, funds such as SDY should see a steadier future because of the dividend history of the companies included in the fund. These are companies that have a commitment to not just paying dividends, but increasing them, consistently, every year. Even when bond rates are high, investors have still sought dividend paying companies because of the safety they provide while also the possibility of capital appreciation, something bonds cannot match. While SDY is currently yielding under 3%, I expect this yield to increase going into 2014. As cash-rich companies enter the new year, they will seek to return more money to shareholders. With stock levels at all-time highs, I think increasing dividends is a much more prudent, and likely, scenario than buying back stock. If dividend payouts do increase, SDY will be a direct beneficiary and its yield will go up, providing an important catalyst for it to trend higher.

Bottom line: Investments in SDY and other similar funds have had an incredible run in 2013. However, the market as a whole is up tremendously, so performance over this year in a particular investment is no indication that the same investment will perform similarly well in 2014. In my opinion, SDY still has plenty of upside, even given its 26% gain year to date. With an investment community still reeling from the 2008-09 crash, rising dividends on the horizon, and continued strong performance by large-cap U.S. stocks (many of which make up SDY), I expect SDY to trend higher into the new year. Given the above reasons, I encourage investors to take a serious look at this fund.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SDY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.