An ETF with a Novel Approach to Dividend Investing

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Yield-hunger investors who are wary of the rising interest rates ahead can turn to a dividend-themed exchange traded fund that specifically focuses on companies with low correlation to interest rates.

The Fidelity Dividend ETF for Rising Rates (NYSEArca: FDRR) "is no longer a hidden gem of the ETF world," Matthew Goulet, Fidelity’s senior vice president of ETF Business Development, told ETF Trends in a call.

"The recent volatility is a wake up call for advisors and provides an opportunity to swap in a different strategy," Goulet added.

FDRR tries to reflect the performance of a group of large and mid-capitalization, dividend-paying companies expected to pay and grow their dividends and have a positive correlation of returns to increasing 10-year U.S. Treasury yields. The positive correlation to Treasury yields and sector neutrality may help protect investors’ returns in rising rate environments, when high-yielding stocks and sectors tend to underperform.

"As advisors, you want the yield but can't hold only defensive sectors," Goulet  explained, referring to defensive sectors like bond-esque utilities that are negatively affected by rising rates.

Looking at FDRR’s portfolio construction methodology, the underlying Fidelity Dividend Index for Rising Rates employs a multi-factor approach, including a 63% weight toward companies with higher dividend yields, and smaller 13.5% to avoid firms with payouts that are too high and might be cut in the future, 13.5% to stocks with dividends that are growing and 10% to firms that perform better with rising rates.

Stocks with steady 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.

The smart beta dividend ETF may be a great way to access market exposure that exhibits relatively low correlation to traditional defensive plays. Specifically, FDRR includes a 25.4% tilt toward the technology segment, which has seen an increase in dividend growth in recent years and may continue to be a source of higher payouts after the recent tax reforms and tax holiday for repatriating cash from overseas revenue streams. The fund includes 15.3% to financials, health care and 11.8% consumer discretionary.

Despite its focus on dividend-generating stocks outside of traditional dividend payers like utilities, FDRR still shows a 3.01% 30-day SEC yield. The ETF "looks to yields in different places and still generates a healthy yield with a neutral sector approach," Goulet said.

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