It's hard to beat High Yield ETFs for diversified income. But which one is best? Let's search the market for the best High Yield ETF.
Let's run a screen with the following criteria:
- 3% Minimum Yield - High yield is the name of the game.
- $200 Million Minimum Assets - Large enough be run efficiently and have ample liquidity.
- Index Funds Only - We'll save on expenses and guard against underperformance by screening out actively managed funds.
- Equity Only - No bond funds, we want the chance for capital appreciation and dividend growth.
- Domestic Only - We'll take advantage of a degree of inflation protection by staying in American equities.
- Broad Market Only - We'll guard against being in the wrong sector at the wrong time by screening out sector funds.
The Divine Nine
There are nine ETFs that meet our criteria: iShares Select Dividend ETF (NYSEARCA:DVY), Vanguard High Dividend Yield ETF (NYSEARCA:VYM), iShares Core High Dividend ETF, (NYSEARCA:HDV), PowerShares S&P 500 High Dividend Low Volatility (NYSEARCA:SPHD), First Trust Morningstar Dividend Leaders Index Fund, (NYSEARCA:FDL), ALPS Sector Dividend Dogs ETF, (NYSEARCA:SDOG), WisdomTree High Dividend Fund (NYSEARCA:DHS), PowerShares High Yield Equity Dividend Achievers (NYSEARCA:PEY), and FlexShares Quality Dividend Defensive Index Fund (NYSEARCA:QDEF).
How They Stack Up
Most of the ETFs have similar yields, but iShares Core High Dividend stands above the rest:
iShares Select Dividend and Vanguard High Dividend Yield are easily the largest High Yield ETFs:
For the Vanguard High Dividend Yield, that size translates to the lowest expense ratio in the field. But no savings for iShares Select Dividend.
One thing most of these ETFs have in common is that they've been doing quite well. PowerShares Dividend Achievers especially.
The funds have decent diversification all around, but the Vanguard and WisdomTree High Dividend funds have the most holdings by far.
Making Some Cuts
FlexShares Quality Dividend Defensive Index Fund has not performed well in a favorable environment for the yielders.
But it never claimed to be a high yield fund - it's a "Quality Dividend Defensive Index Fund". It ended up on the list because it's a large non-sector index fund with a yield over 3%.
Its numbers say "cut me", but we will leave it on the list for now, as it may be an interesting play in its own right.
Vanguard vs. WisdomTree
The similar number of holdings in the Vanguard and WisdomTree funds lead us to believe they are essentially the same fund. But the performance of late has diverged. Let's have a look.
The Vanguard fund follows the FTSE High Dividend Yield Index, which is comprised of the highest yielding mega, large, and mid-cap stocks. The index is market cap weighted, allowing Vanguard's fund to have low turnover and very low expenses. Its top holdings at the end of Q1 were:
The WisdomTree fund tracks WisdomTree's own High Dividend Index. The index selects the highest yielding 30% of stocks with market caps over $200 million and ample liquidity, and then weights the stocks by the total dollar amount of dividends paid. This is similar to the typical "cap-weighted" fund like SPDR S&P 500 (NYSEARCA:SPY) or VYM, but instead of total dollar amount of market cap, the index uses total dollar amount of dividends. This requires resizing positions each year, and helps explain WisdomTree's relatively high expenses. The top holdings for the WisdomTree index at the end of the week (WisdomTree gives more current information) were:
So the two funds have similar holdings, but different weightings of those holdings, and a different overall methodology. We would like to dismiss the WisdomTree fund for its higher expenses, but its methodology may be proving itself with superior performance, and it should generally have a higher yield than the Vanguard fund.
We can't dismiss the Vanguard fund either. Vanguard's reputation is terrific and longstanding, and it offers the lowest expenses for terrific high yield diversification.
Both of these funds are excellent High Yield ETFs.
iShares Select vs. First Trust
So we are not having any luck thinning the herd. Let's see if we can eliminate either iShares Select or First Trust Morningstar. These two look similar in number of holdings, and pretty similar in performance.
iShares Select tracks the Dow Jones U.S. Select Dividend Index. This index is comprised of one hundred high yield stocks that are weighted by dividends per share. Note that this is not yield weighted, with the highest yielding stocks being the largest, but dollar amount of dividends per share weighted.
This results in very-high-price-per-share stocks being over-weighted. Lockheed Martin is the number one holding, not because it has a high yield, but because it trades for more than $200 per share, and yields more than $6 per share.
This might be arbitrary if the iShares Select ETF had a very low expense ratio, but to pay extra for this "strategy" is ludicrous. We note with consternation that iShares Select has been one of the best performers, but we think its slight outperformance was just noise. We are cutting iShares Select from the list.
Can First Trust Survive?
No, it cannot. The First Trust Morningstar Dividend Leaders Index Fund tracks the Morningstar Dividend Leaders Index. This takes the top 100 yielding stocks that pass screens for sustainability, and then weights them by total dollar amount of dividends, like WisdomTree.
The problem with this is that First Trust has less than a quarter the number of stocks that WisdomTree has, and the total dollar weighting makes the fund top heavy. Two-fifths of the fund is invested in just five stocks:
The second highest expense ratio for a fund that doesn't even provide broad diversification? We cannot countenance that. Off of the list goes the First Trust Morningstar Dividend Leaders fund.
iShares Other Fund
Let's see how the iShares Core High Dividend fund fares. It tracks the Morningstar Dividend Yield Focus Index. This index consists of just 75 high yield stocks that are screened for health and sustainability. They are then weighted by total dollar amount of dividends, like WisdomTree and First Trust.
As with First Trust, the small pool of stocks ends up overweighting the top stocks significantly:
But the expense ratio is quite low.
So on the positive side, the fund offers the strategy of WisdomTree and First Trust without having to pay up for it.
On the negative side, the fund does not offer the diversification of the WisdomTree fund, and iShares has underperformed a little as well. What to do?
We will bless this low-cost fund, with the asterisk that the fund is not very well diversified, and a conservative investor may want to make it part of a portfolio of funds.
PowerShares Low Volatility
Here is a fund that is doing something for your expense money.
The PowerShares S&P 500 High Dividend Low Volatility fund tracks the S&P Low Volatility High Dividend index. This index is comprised of the 50 least volatile, highest yielding stocks in the S&P 500.
This fund is yield-weighted, making the highest yielders the largest holdings. But the fund also limits each stock to a 3% maximum weight, and has a maximum 25% weight by sector. The rebalancing is done twice per year, and result is a well diversified fund of high quality, high yielding stocks.
An expense ratio of 0.3% looks like a bargain for that service. And in addition to having a sound strategy, the fund has had the best performance, too.
With that, the PowerShares S&P 500 High Dividend Low Volatility fund leaps to the top of our list of the best High Yield ETFs.
The Dividend Dogs
The ALPS Sector Dividend Dogs ETF is an interesting one. It tracks the S-Network Sector Dividend Dogs Index.
This index is reconstituted annually and rebalanced quarterly. The index consists of the five stocks in each of the ten market sectors with the highest yield. Each of the 50 stocks is then equally weighted.
We like this fund, but we prefer the PowerShares methodology of caps for stocks and sectors instead of equal weights. There is no rule that the economy should be equally divided amongst ten sectors, and the Dividend Dogs will tend to over-represent the smaller sectors and under-represent the larger ones.
The Dogs ETF also lags PowerShares a little in performance, yield, and expenses. But we like it, and it has a place for the investor that wants high yield and strict sector diversification. It stays on the list as an honorable mention.
Can another PowerShares fund supplant PowerShares Low Volatility for the top spot? Let's see.
The PowerShares High Yield Equity Dividend Achievers fund tracks the Dividend Achiever 50 Index. This index tracks stocks that have increased their dividend each year for the last 10 years or more. The top fifty yielding stocks are chosen, and then yield-weighted, with the highest yielding stocks being largest. This is similar to the PowerShares Low Volatility fund's index, and here also there are caps by sector and individual stock:
- no more than 12 stocks per sector
- 25% cap by sector
- 4% cap for individual stocks
High yield and dividend growth, along with structural diversification. Pretty great. About the only thing not to like here is the expense ratio. At 0.55%, it is easily the highest in the group. Were it not for that, this fund would come out on top. As it is, we will leave it on the list as an honorable mention.
If you are interested in these high yielding Achiever stocks, we recently reviewed the top 13 by yield.
Back to the Defensive ETF
So now that we see what the competition is like, let's revisit the FlexShares Quality Dividend Defensive fund. This ETF tracks the Northern Trust Quality Dividend Defensive Index.
Like with the PowerShares Low Volatility fund's index, this Defensive index screens for low volatility, as well as high yield and sustainability. The weightings for each stock depend upon their yield and beta, rather than just being cap-weighted or yield-weighted.
For all its fanciness, the Defensive ETF lags PowerShares Low Volatility ETF by every measure, and adds nothing special. Off the list it goes.
The Six Best High Yield ETFs in the Market
So here are our choices for the best high yield ETFs in the market.
It's hard to beat High Yield ETFs for diversified income. Six in particular may be the best:
- The Vanguard High Dividend Yield ETF provides broad exposure for a very low fee.
- The iShares Core High Dividend ETF tilts toward the higher yielding names for very low cost, but lacks in diversification.
- The ALPS Sector Dividend Dogs ETF provides strict sector diversification.
- The WisdomTree High Dividend Fund tilts toward the higher yielding names like iShares Core. It is more diversified, but with higher expenses.
- PowerShares High Yield Equity Dividend Achievers is enviable for dividend growth, income, and everything else except cost.
- The PowerShares S&P 500 High Dividend Low Volatility fund looks to us like the best of all. It intelligently over-weights high yield with caps on individual stocks and sectors, and does so for a very reasonable cost.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.