Non-Streak Dividend ETFs Impress

When it comes to income investing, perhaps the only thing sweeter than the dividend itself is a steadily rising dividend. Clearly, income investors love knowing that some companies raise dividends year after year.

That helps explain why investors continue to allocate capital to such familiar names as Coca-Cola (NYSE:KO), Johnson & Johnson (NYSE:JNJ) and Procter & Gamble (NYSE:PG).

Those blue chips and plenty of others have lengthy histories of increasing their payouts. In the cases of J&J and P&G, those dividend increase streaks are now beyond five decades. ETF sponsors have capitalized on the trend of investors' desire for steadily rising payouts by constructing funds that use length of dividend increase streaks as a primary screening criteria.

In fact, the two largest U.S. dividend ETFs, the Vanguard Dividend Appreciation ETF (NYSE:VIG) and the SPDR S&P Dividend ETF (NYSE:SDY), both use dividend increase streaks as the way for filtering possible constituents. VIG tracks the NASDAQ US Dividend Achievers Select Index, which requires constituents to have increased dividends every year for at least the past decade.

SDY tracks the S&P High Yield Dividend Aristocrats Index, which requires a dividend increase streak of 25 years. Combined, these two ETFs have about $25.8 billion in assets under management, indicating investors are quite comfortable with these ETFs, although both yield less than three percent.

However, for all the assets VIG and SDY have accumulated and for all the attention these ETFs get in the mainstream media and the blogosphere, investors should consider alternative weighting methodologies with dividend ETFs. The proof is in the proverbial pudding as some ETFs that do not use dividend increase streaks as a primary weighting tool have performed well over the past several years. Among that group are ETFs that weigh by yield.

Weigh By Yield Another common strategy employed by dividend ETFs is weighting fund components by yield. Vanguard offers a yield-weighted alternative to VIG in the form of the popular Vanguard High Yield Dividend ETF (NYSE:VYM). VYM tracks the FTSE High Dividend Yield Index, which measures the investment return of common stocks of companies characterized by high dividend yields, according to the issuer.

VYM had $7.5 billion in assets at the end of March. The iShares High Dividend Equity Fund (NYSE:HDV) tracks the Morningstar Dividend Yield Focus Index, which focuses only companies that pay dividends that are considered qualified income, so no real estate investment trusts are found in this ETF. The index takes the top 75 companies by yield and filters for those that "have a Morningstar Economic Moat rating of narrow or wide and have a Morningstar Distance to Default score in the top 50% of eligible dividend-paying companies," according to Morningstar.

HDV has amassed $3.2 billion in AUM barely more than two years of trading. The First Trust Morningstar Dividend Leaders Index Fund (NYSE:FDL) follows the Morningstar Dividend Leaders Index. That index "captures the performance of 100 highest yielding stocks that have a consistent record of dividend payment and have the ability to sustain their dividend payments. Stocks in the index are weighted in proportion to the total pool of dividends available to investors," according to Morningstar.

While FDL is not as big as its aforementioned peers, the ETF is not exactly small. The ETF has nearly $610 million in assets under management and its underlying index has consistently outperformed the S&P 500 over one-, three- and five-year time frames with a lower a standard deviation, according to First Trust data.

Speaking Of Returns Including paid dividends, SDY and VIG are up 21.3 percent and 16.2 percent, respectively, over the past 12 months. Obviously, that is not too shabby. However, investors have been compensated by reaching for some added yield. Over the same time, the average return delivered by FDL, HDV and VYM was 21.7 percent.

Interestingly, all three of those ETFs less volatile than SDY and VIG as well.

Moving out to a two-year time frame, HDV is not only the best performer of the group with a return of 38.6 percent, but that ETF has also been the least volatile of the five funds highlighted here. While being nearly 400 basis points less volatile than SDY, HDV has outpaced that ETF by 870 basis points over the past two years.

Since April 2011, FDL, HDV and VYM have generated average returns of nearly 35 percent. The average return offered by SDY and VIG over the same time is 26.4 percent.

To be clear, this analysis is not intended to knock VIG and SDY. These are fine ETFs in their own right and if investors prefer to own ETF that strives to include steady dividend raisers, than VIG and SDY are excellent bets. And of course, as a Vanguard ETF, VIG offers a paltry expense ratio of just 0.13 percent, making it less expensive than 88 percent of comparable funds.

Then again, not only has VYM been the better performer, but it has the lower expense ratio at 0.1 percent, making it cheaper than 92 percent of similar ETFs.

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