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ETFs For a Dovish Fed

By ETFs

The Federal Reserve is slated to release minutes of last month's meeting today, clarifying the central bank's decision to stand pat on interest rates. The closer look into the Fed's inner workings may also help steer investors toward certain exchange traded funds for this ongoing low-yield environment.

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Fed Chair Janet Yellen has urged caution on raising rates in light of a slowdown in global markets and falling commodities prices. Consequently, without the specter of interest rate hikes anytime soon, investors may target some asset categories and ETFs to capitalize on a more dovish Fed outlook.

With benchmark 10-year Treasury yields still hovering below 2.0%, investors will turn to riskier assets that generate more attractive yields, like dividend ETFs. Moreover, given the ongoing market volatility and uncertainty, investors may look to the quality and value investment themes, including a group of dividend aristocrats or dividend growers. For instance, the Schwab US Dividend Equity ETF (SCHD) includes 100 stocks based on strong fundamentals, dividend yields and consistent dividend payouts for at least 10 consecutive years, and it has a 2.93% 12-month yield. The SPDR S&P Dividend ETF (SDY) holds firms that have a minimum dividend increase streak of 20 years for inclusion and shows a 2.44% 12-month yield. The ProShares S&P 500 Aristocrats ETF (NOBL) only includes companies that have increased their dividends for at least 25 consecutive years and offers a 1.92% 12-month yield.

Company stocks that issue high yields may be masking their distressed books or may not be sustainable and are heading for dividend cuts. On the other hand, these quality dividend ETFs try to limit the impact of these value traps by selecting components based on a history of sustainable dividend growth.

The World of ETFs

Alternatively, investors may choose from a number of multi-factor dividend ETFs that select components based on more than quality dividend payers.

For instance, the Elkhorn FTSE RAFI U.S. Equity Income ETF (ELKU) follows high yield U.S. stocks screened for fundamental factors to target sustainable income. The underlying index screens for financial health based on the return on assets, cash flow to short-term debt plus interest expenses and net operating asset scaled by total assets. Fundamental weights include sales averaged over the prior five years, cash flow averaged over the prior five years, book value at the review date and dividend distribution averaged over the past five years. ELKU's underlying index shows a dividend yield of 3.55%.

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The O’Shares FTSE US Quality Dividend ETF (OUSA), the first exchange traded fund from “Shark Tank” personality Kevin O’Leary, also combines dividends along with the low volatility and quality factors to lower exposure to high-dividend equities that have experienced large price dips. OUSA's index has a 3.4% yield.

The FlexShares Quality Dividend Index Fund (QDF) focuses on the quality factor, which includes a company’s ability to generate free cash, dividend growth and stability. Another element that has been critical to QDF’s success is the emphasis on management efficiency and a company’s ability to generate cash. QDF has a 2.89% 12-month yield.

The Compass EMP US Large Cap High Dividend 100 Volatility Weighted Index ETF (Nasdaq:CDL) tracks the highest 100 dividend yielding stocks of the CEMP U.S. Large Cap 500 Volatility Weighted Index, which includes stocks that show four quarters of positive earnings and are weighted based on their daily standard deviation, or volatility. The combination of low volatility and positive earnings also reflect stable dividend paying companies. CDL has a 3.33% 30-day SEC yield.

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The SPDR Russell 1000 Yield Focus ETF (ONEY) also includes a combination of core factors like high value, high quality and low size characteristics, along with a high yield characteristic. ONEY's index dividend yield is 3.52%.

Additionally, the Legg Mason Low Volatility High Dividend ETF (Nasdaq:LVHD) should help investors who are seeking new sources of yield in a changing market environment. LVHD selects U.S. equity stocks with relatively high yield and low price and earnings volatility, and the fund only selects profitable companies. LVHD has a 4.08% 30-day SEC yield.

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With the Fed holding interest rates and only anticipating two rate hikes this year, fixed-income investors may also turn to riskier high-yield securities, like speculative grade and emerging market debt

After the selling over the past year, high-yield or junk bonds look cheaper and yields appear much more attractive. For instance, the popular SPDR Barclays High Yield Bond ETF (JNK) has a 7.14% 30-day SEC yield and iShares iBoxx $ High Yield Corporate Bond ETF (HYG) has a 6.95% 30-day SEC yield.

Emerging market bonds are also enjoying the more risk-on attitude after the poor performance in the developing markets. Additionally, the weakening U.S. dollar has also made emerging assets more attractive.

Fixed-income investors can gain exposure to the developing market sovereign debt through a number of options. For local currency-denominated emerging market bond ETFs, the iShares Emerging Markets Local Currency Bond ETF (LEMB) has a 4.37% 30-day SEC yield. The Market Vectors Emerging Markets Local Currency Bond ETF (EMLC) has a 5.58% 30-day SEC yield.

Moreover, if the Fed maintains an extended low-rate outlook, the U.S. dollar will continue to come under pressure without the central bank there to support the greenback with a tighter monetary policy. Consequently, gold may continue to shine.

For gold exposure, the SPDR Gold Shares (GLD), the world’s largest ETF backed by physical holdings of gold, has been a go-to option for large traders, hedge funds and institutional investors seeking to capitalize on its large pool of liquidity and tight bid-ask spreads. Similarly, the iShares Gold Trust (IAU) is another large option with a lot of active trading. Individual retail investors who do not need to move millions of dollars of gold but would rather sit on to their gold exposure may find IAU a cheap buy-and-hold option. Something like GLD would be a better play for large institutional-sized traders who execute huge trades due to the fund’s tight spreads and activity.

Alternatively, since IAU and GLD shares are backed by gold stored in London vaults, investors can take a look at the ETFS Physical Swiss Gold Shares (SGOL) to diversify gold exposure. If something were to happen in London that could affect the gold stored there, SGOL investors will be relieved to know that their gold exposure is stored in Swiss vaults.

This article was provided by our partners at etftrends.com.

For full disclosure: Tom Lydon's clients own shares of SDY, NOBL, JNK, HYG, GLD.

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