Lingering Low Rates Will Boost DVY

| About: iShares Select (DVY)


The Fed's reluctance to raise rates will provide a boost to dividend paying funds.

Companies in DVY's portfolio have a proven track record of paying dividends.

DVY has outperformed many comparable funds this year, and should continue to do so.

The purpose of this article is to determine the attractiveness of the iShares Select Dividend ETF (NYSEARCA:DVY) as an investment option. To do so, I will review DVY's recent performance, current holdings and weightings, and trends in the market to attempt to determine where DVY may be headed for the rest of 2016. Given the Fed's recent decision to not raise interest rates this month, it is an opportune time to consider whether DVY is still a profitable investment.

First, a little about DVY. The fund seeks investment results that correspond with the price and yield performance of the Dow Jones U.S. Select Dividend Index. The Index is generally made up of companies with comparably high dividend yields and who have paid out dividends for a minimum of five consecutive years. DVY is currently trading at $80.56/share and pays a quarterly dividend of $.63/share, which translates to an annual yield of 3.13%. The fund has done extremely well year to date, with a return of over 7%, not including its first quarter dividend. This compares to a gain of just under 1% in the Dow Jones Index, a popular benchmark. However, DVY is not designed to track the DOW, so comparing it to other dividend funds is appropriate. Two extremely popular funds, Vanguard High Dividend Yield ETF (NYSEARCA:VYM) and Vanguard Dividend Appreciation ETF (NYSEARCA:VIG) also underperform the DVY with returns of just over 2.5% and almost 4% year to date (also excluding dividends). DVY's recent performance is impressive, and there are a few reasons that I believe this performance will continue.

First, and probably most important, interest rates are staying near historic lows for longer than anticipated, as the Fed has not made another increase since its first rate hike in December. This has surprised most market participants, and indexes have moved higher as a result. For instance, back in January before the jobs report, 45% of traders had anticipated a March rate increase. After the positive January report, that number rose to over 50%. Fast forward to April and there has still not been another rate hike, and there is reason to believe the dovish Fed will continue to remain dovish. During last Tuesday's meeting, Yellen stated the central bank will move "cautiously" with regards to further hikes. The market has reacted very positive to that phrasing, which assumes the Fed plans to continue its dovish stance well in to 2016. This is a very positive catalyst for dividend-paying funds, especially in the short-term. Yields on government bonds and savings accounts will remain low, and investors will continue to favor dividend-paying companies for the yield they provide.

A second reason I prefer DVY has to do with its unique holdings, specifically its sector weightings. As of 4/8/16, almost 33% of its market value is in the utilities sector. This is notable because utility companies are known for having consistent revenue streams, and paying out consistently high dividends. This exposure has been one of the primary reasons why DVY has outperformed other dividend funds, as I mentioned earlier. The utilities sector thrives during periods of low interest rates, so there is a very good chance this outperformance will continue. To put this in perspective, consider that the utilities sector makes up 8.5% and 2.70% of the portfolios of VYM and VIG, respectively. This is a critical distinction and a key reason I favor DVY. On a related note, DVY's next highest sector weighting is the Financials sector, which makes up over 13% of the fund. I like this exposure because financials, such as banks or insurance companies, tend to do well when interest rates rise. This provides a nice hedge for DVY if and when rates do go up, and will offset some underperformance that might occur due to its high utilities exposure. Therefore, I see DVY having a great balance in its portfolio to be able to capitalize on the short-term gains from low rates, but also positioned to take advantage of rising rates in the future.

A third reason I like DVY has to do with its yield. Currently over 3%, it bests the majority of dividend funds that have seen their prices bid up so that their yields are now under 3%. To continue its comparison with VYM and VIG, DVY again bests these funds, which have current yields of 2.80% and 2.03%, respectively, based on their most recent payouts. Given that the companies that make up DVY have a solid history of dividend payouts, the yield is relatively safe and will continue to entice investors as rates stay low.

Of course, investing in DVY is not without risk. For one, the Fed could decide to abruptly change its course regarding rates, and raise them quicker than anticipated, or by more than anticipated. This would surely spook the market, and dividend paying funds would be hit especially hard as investors rotate out of those funds and into other investments such as bonds that would have become more attractive. However, I do not see this scenario occurring, and expect the increases in interest rates to be slow and gradual, which should prevent any type of mass exodus out of dividend paying funds.

Bottomline: DVY has performed extremely well in 2016, thanks to its heavy exposure to the utilities sector and continued low interest rates. Given the reasons for its strong performance, there is a good chance this investment will continue to be profitable as we push in to 2016. When compared to other dividend paying funds, DVY has given investors a better overall return, with more capital appreciation and a higher yield to boot. With a low beta of just .67, DVY is a solid investment to earn income, while keeping investors from losing their shirts in a downtown. Given the Fed's continued reluctance to raise rates, I would encourage investors to take a serious look at this fund.

Disclosure: I am/we are 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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