Buy The Vanguard High Dividend Yield ETF In 2014

| About: Vanguard High (VYM)


Expect 2014 to continue to be a good year for dividend paying funds.

The cost to own the fund is a fraction of the cost of mutual funds.

VYM is very evenly distributed among multiple asset classes.

The purpose of this article is to discuss the attractiveness of the Vanguard High Dividend Yield ETF (NYSEARCA:VYM) as an investment option. To do so I will look at recent fund performance, current holdings and allocation, and trends in the market to attempt to determine how well it will do in 2014.

First, a little about VYM. The Fund is an open-end investment managed by Vanguard. VYM seeks to track the performance of an index that measures the investment return of common stocks of companies that are characterized by high dividend yield. At the time of writing, VYM is trading at $62.52/share and pays a quarterly dividend of $.53/share, which translates to an annual yield of 3.4%. Recently, the fund has performed strongly, as 2013 was a strong year for the market overall and investor interest in dividend paying funds helped VYM book a 14% gain over the past 52 weeks (excluding dividends). Year-to-date the fund is up slightly, at .32%, but this compares to a drop of about 1.4% for the Dow Jones Index (Private:DJI) as a whole, so the VYM has outperformed the DJI so far this year.

Clearly, recent investors in VYM have been rewarded. However, strong performance alone is not a good enough differentiator going forward, as the market as a whole has rallied strongly since 2013. Pretty much all of the large dividend funds, such as the SPDR S&P Dividend ETF (NYSEARCA:SDY), the iShares Select Dividend ETF (NYSEARCA:DVY), and the Vanguard Dividend Appreciation Idx ETF (NYSEARCA:VIG), among others, have performed in a similar fashion. I will look at the specific holdings of VYM to see if it will be a better investment than its competing funds this year. Here is a list of its top 10 holdings, which make up 34% of the fund's portfolio (as of 2/28/14):

Rank Holding
1 Exxon Mobil Corp. (NYSE:XOM)
2 Microsoft Corp. (NASDAQ:MSFT)
3 General Electric Co. (NYSE:GE)
4 Johnson & Johnson (NYSE:JNJ)
5 Wells Fargo & Co. (NYSE:WFC)
6 Chevron Corp. (NYSE:CVX)
7 JPMorgan Chase & Co. (NYSE:JPM)
8 Procter & Gamble Co. (NYSE:PG)
9 Pfizer Inc. (NYSE:PFE)
10 Verizon Communications Inc. (NYSE:VZ)

The top 10 holdings of VYM are some of the largest and most respected companies in the world, so a bet on this fund is a bet on the market as a whole, which I expect to rise modestly throughout 2014. However, many of these same companies are also top holdings in other funds. For example, XOM, CVX, and PG are also top holdings of VIG. CVX is also a top holding of DVY and McDonald's (NYSE:MCD) is a top component of both SDY and DVY. Therefore, looking at top holdings alone does not always provide much of a differentiator, so it is important to really scrutinize sector weighting when selecting a dividend paying ETF.

With respect to sector allocation, this is where I feel VYM really shines. Not because it is over-weighted in an area that I feel will out-perform, but because it is very evenly distributed across many sectors and should be able to withstand a drop in any one particular sector. I normally list out just the top sectors in a fund, but VYM has five sectors that are so closely weighted, with a few more just slightly behind the others, that I wanted to present a chart showing all the sector weightings of the fund, shown here:

Sector Weighting
Basic Materials 4.20%
Consumer Goods 14.30%
Consumer Services 7.20%
Financials 12.70%
Health Care 12.20%
Industrials 14.60%
Oil & Gas 11.80%
Other 0.00%
Technology 9.50%
Telecommunications 5.30%
Utilities 8.20%

As you can see, VYM is not heavily concentrated in any one area, and is weighted strongly in areas that will perform well in good times and bad, such as consumer goods and industrials. I really prefer the make-up of VYM over some of the other funds because when I screen dividend paying funds I am looking for safe and steady income for the long-term. Funds that rely too much on any one stock or sector have the risk of under-performing or, at least, more volatile trading days because of that influence. VYM does not have a single sector weighing in at more than 15%, so it is about as diversified as a fund can get. This compares with DVY's largest sector weighting of 35% in utilities (as of 3/14/2014) and SDY's largest weighting of 21% in financials (as of 3/14/2014). While those allocations are not "wrong" to own, it does indeed subject the investor to larger swings in their portfolio. That strategy will make sense for some investors, but not others. For a risk averse investor, VYM makes for a logical choice.

An additional advantage of VYM is its low expense ratio. While many mutual funds charge in the range of 1-2% annually, VYM has an expense ratio of just .10%. This is extremely low, and for the amount of diversification VYM provides, with a current portfolio of 378 stocks, is an absolute bargain for the money. Even compared to other ETFs this fund is cheap to own, with SDY charging an expense ratio of .35% and DVY charging .40%. VIG, also managed by Vanguard, has an identical expense ratio, but holds about half the number of stocks as VYM, so I give VYM the edge here as well. Saving on expense fees can really add up over time, especially for long-term investors who hold these funds for years, and can help compound returns, to the point where it can make up for a slightly lower yield or price return.

Bottom-line: VYM investors have benefited over the past 18 months as the stock market rallied and interest in dividend paying funds soared. However, it is not too late to get in on this investment trend, as interest rates continue to stay low, consumer spending in the U.S. is rising, and unemployment continues to drop, in the U.S. and elsewhere. With the historic rise in the market, many investors, including myself, have begun to prepare for some type of correction. VYM, sporting a dividend yield above 3% and a beta of .79, provides investors with a solid level of protection during down times. I would encourage investors to take a serious look at this fund in 2014.

Disclosure: I am long DVY. 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.

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