Exchange traded funds with an emphasis on dividends have become increasingly popular. But all dividend ETFs are not created equal and some sport higher expense ratios that can erode yields and total returns.
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Although it appears as though the Federal Reserve will again pass on raising interest rates at its September meeting, interest rates will rise at some point in the U.S. and those higher borrowing costs could pressure from dividend ETFs. In other words, the Fidelity Dividend ETF for Rising Rates (NYSEArca: FDRR) could prove to be well-timed new dividend ETF.
The Fidelity Dividend ETF for Rising Rates debuted last week as part of Fidelity’s new suite of six smart beta ETFs. FDRR will track large- and mid-cap dividend-paying companies expected to continue to pay and grow dividends and have a positive correlation of returns to increasing 10-year U.S. Treasury yields. Underlying stocks can include those with historically high dividend yields, low dividend payout ratios, high dividend growth, and a positive correlation of returns to rising 10-year U.S. Treasury bond yields.
Dividend growth as a means of trumping inflation could and arguably should serve to highlight the advantages of the ETFs that focus on dividend growth stocks. That group is comprised of well-established ETFs that emphasize dividend increase streaks as well as a new breed of funds that look for sectors chock full of stocks that have the potential to be future sources of dividend growth.
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Stocks with steady dividend yields reassure investors of a company’s strong financial health. Additionally, dividend-paying stocks typically outperform those that do not pay over the long haul, with less volatility, due to the compounding effect of dividends on the investment’s overall return. Over the past 40 years, companies that boost payouts have proven to be less volatile than their counterparts that cut, suspended or did not initiate or raise dividends.
“FDRR takes into account not just dividend yield, dividend growth and dividend payout ratio, but also adds in correlation to the 10-year treasury rate. As you can see in the chart below, in the process of building a composite score for each stock, one of the criteria is correlation to changes in the 10-year treasury rate. While this only is a 10% in determining the composite score for each stock, it is clear this has an impact on the holdings of FDRR because sectors like Utilities and Real Estate are significantly underweighted compared to other dividend ETFs,” according to a Seeking Alpha analysis of the new ETF.
For more information on new fund products, visit our new ETFs category.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
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