A Prime Avenue To Mid-Cap Dividends

Large-cap stocks are usually thought of as the best dividend destinations, but dividend investors should not sleep on mid-caps. In fact, there is ample room for dividend growth among U.S. mid-caps. At the end of last year, just over 70 percent of the S&P mid-cap 400 paid dividends.

Rather than stock-picking, investors looking for mid-cap dividends should consider the WisdomTree MidCap Dividend Fund (ETF) (NYSE:DON). DON, which is nearly a decade old, is home to over $1.5 billion in assets under management.

There are good reasons to consider a passive approach to mid-caps, dividends or otherwise. Namely, active managers of mid-cap funds, particularly growth funds, have a tendency to underperform their benchmarks.

Just 20 percent of all mid-cap growth and 12 percent of all small-cap growth funds outperformed the S&P MidCap 400 Growth and the S&P SmallCap 600 Growth indices, respectively. Meanwhile, 51 percent of all large-cap growth funds outperformed the S&P 500 Growth index, said S&P Capital IQ.

Looking Closer At DON

Though DON is passively managed, its underlying index 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.

DON has a distribution yield of 1.34 percent, which is reflective of mid-cap dividend stocks' status as more dividend growth than high-yield destination.

By weighting mid-cap stocks by the dollar amount of dividends paid, the fund provides a less aggressive approach to dividend investing compared with funds that concentrate in the highest-yielding stocks, said Morningstar of DON. The fund takes small positions in several hundred stocks that pay a dividend and have a market capitalization below that of the 300th-largest dividend payer. It could serve as a suitable satellite holding for investors seeking mid-cap exposure who believe in the fund's dividend-weighting approach.

DON allocates almost 41.5 percent of its combined weight to the financial services and consumer discretionary sectors, two groups that have been major contributors of U.S. dividend growth in recent years. That is a slight overweight to those sectors as the S&P MidCap 400 devotes almost 39 percent of its combined weight to financial services and consumer discretionary stocks.

Most of DON's financial services weight goes to real estate stocks. Utilities and industrials combine for about a third of DON's weight. Combine the real estate exposure and the utilities weight, and it is not surprising that DON is benefiting as the Fed moves away from boosting interest rates four times this year. That is likely why the ETF hit a new high last Friday.

With roughly 400 holdings, the fund is not overly concentrated in any one stock. Sector exposures can vary from the typical index fund in that category. After the financial crisis, the index changed its methodology to include a 25 percent cap on each sector. It currently has greater exposure to the consumer cyclical and industrial sectors and less exposure to financials, healthcare, and technology than the mid-value category average, added Morningstar.

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