Conventional wisdom says dividend stocks and some payout-based exchange traded funds are supposed to be conservative investments.
However, not all dividend ETFs make good on that promise. In particular, the array of dividend funds that select and weight stocks based on yield can exposure investors to myriad risks, including frothy valuations, dividend cuts and suspensions and interest rate risk due to often excessive weights to rate-sensitive sectors.
Although it is down 6.8 percent year-to-date, the WisdomTree High Dividend Fund (NYSE:DHS) has the potential to regain favor among conservative dividend investor, particularly if the Federal Reserve continues to pass on raising interest rates. That is to say DHS has some sensitivity higher interest rates by way of a combined 21.5 percent weight to telecom and utilities stocks, two sectors with reputations for lagging after Fed liftoff.
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The WisdomTree High Dividend Index (WTHYE) is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year, based on the most recently declared dividend per share, according to WisdomTree.
Though the index currently trades at a slight price-to-earnings ratio premium to the S&P 500, there is an emphasis on the value factor with DHS.
The fund's value exposure has been deeper than most large-value funds, although it has drifted over time, according to a recent Morningstar research note. Currently, the fund's value tilt is more modest, and it gives an underweighting to financials relative to the Russell 1000 Value Index. The fund will naturally shift toward the highest-yielding stocks and sectors at rebalance.
At almost 17.2 percent, financials services is the largest sector weight in DHS. With energy the ETF's third-largest sector weight at 13.3 percent, DHS has some protection against higher interest rates because cyclical energy names are historically stout performers after the Fed boosts borrowing costs.
DHS, however, is not a free lunch because, as was noted earlier, there are risks associated with high-yield dividend stocks.
Dividend-paying stocks have historically outperformed the market. Between 1927 and 2014, stocks that pay a dividend have beaten the total market by about 0.7 percentage points annualized. Stocks in the highest-yielding 30% of the market have done even better, outperforming by about 1.5 percentage points annualized. However, high-yielding stocks can be risky. The highest-yielding stocks have had greater volatility than the broader market because some of these stocks are distressed and may offer an attractive yield as compensation for risk, according to Morningstar.
To be fair, DHS has been slightly less than the two largest high-yield dividend ETFs over the past three years and DHS pays a monthly dividend -- something its rivals do not do.
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