After being rather unpopular for the past 20 years or so, it seems the dividend-focused investment strategy has once again gone mainstream. You needn't look further than soaring demand for dividend-oriented exchange-traded funds (ETFs) to recognize this.
Since I recommended the iShares Dow Jones Select Dividend Index (NYSE: DVY) to subscribers of Motley Fool Income Investor via The ABCs of ETFs special report, the fund has ballooned to $7.4 billion in total assets, making it one of the fastest-growing funds during that period.
But other ETF providers have certainly taken notice of Select Dividend's success, and a slew of new dividend-focused offerings now pepper the landscape. Given this development -- and the fact that I've received quite a few emails lately from investors seeking information about these new offerings -- let's check out the best dividend-oriented ETFs around.
The ETF solution
It's easy to see the appeal of these funds, since they give you the opportunity to achieve instant diversity among dividend-paying companies that have been screened with the same strict criteria -- and to do so with relatively low expenses. And they're made even more attractive by the low interest rates we've enjoyed for the past several years. After all, if you can achieve a yield similar to that of the 10-year Treasury bond yet maintain the potential for significant capital appreciation, you're getting the best of all worlds. And that's exactly what these funds have offered since their inception.
Which of these is not like the other?
Launched in November 2003, the iShares offering is the category's original fund. In this case, first also means favorite: It remains my top choice among dividend-oriented ETFs. Some have suggested that, although it is the oldest in the group, Select Dividend is unproven because of its relatively short track record. While this may be true, the companies held within the fund are well established.
Select Dividend invests in the 100 highest-yielding companies in the Dow Jones U.S. Total Market Index (up from 50 when it began) and has produced some phenomenal returns. It's returned a total of 29% vs. the S&P 500's (AMEX: SPY) 17% since my recommendation, yet it still boasts a respectable 3% distribution yield.
With quality blue-chip names peppering its core holdings, this is a welcome addition to any income-oriented portfolio. Better still, this ETF also has one of the lowest expense ratios in the class, at just 0.40%.
Select Dividend's relatively instant diversity and its screening process are well worth its price. The fund only invests in companies with consistent dividend track records. They must also have a positive historical five-year dividend growth rate, a five-year average payout ratio no greater than 60%, and an average daily trading volume (determined annually) of more than $1.5 million or 200,000 shares.
However, though this is fairly common for income-oriented funds, Select Dividend is heavily weighted in financials and utilities, which compose roughly 60% of the portfolio.
To keep the strategy intact, the index is rebalanced once a year, and each company's weighting is determined by its annual dividend yield.
PowerShares High Yield Dividend Achievers (AMEX: PEY) is second in the sector. This fund, which holds about $450 million in assets and currently yields around 3.35%, tries to match the performance of the Mergent Dividend Achievers Index by investing in the 50 highest-yielding companies among those that have increased their dividends in each of the past 10 years. Like Select Dividend, the PowerShares fund determines its company weightings by its yield. In this case, though, the list is rebalanced quarterly, not annually.
Thus, Dividend Achievers is a reasonable choice, but its fee is a touch higher at 0.50% and it's even more focused than Select Dividend. Not only does it own half as many stocks, but also a full 80% of the portfolio is made up of financials and utilities. Further, it has more exposure to mid- and small-cap stocks, whereas Select Dividend is mainly a large-cap fund (though this in itself isn't a bad thing).
More ponies in the stable
PowerShares has three more promising dividend ETFs in the works. The first fund will use the same evaluation process as Dividend Achievers. It will, however, expand its holdings to include all 314 stocks that pass the screen, effectively giving you the same benefits as Dividend Achievers but with greater diversity. Next is a fund that will hold a basket of 100 stocks growing dividends at above-average rates. Finally, and perhaps most exciting, the third will present a broad array of dividend-paying ADRs -- the first ETF of its kind, as far as I know.
Standard & Poor's also announced in May that it will launch the S&P 500 Dividend Aristocrats Index, which is designed to measure the performance of S&P 500 companies that have steadily increased their annual payouts for at least 25 years and is slated to include arguably the 68 highest-quality companies within the S&P 500. Indeed, the Dividend Aristocrats have outperformed the S&P 500 index with less volatility over the past 15 years. In a deviation from the two funds currently on the market, this new dividend index will be equal-weighted as opposed to yield-based, which should make it more diversified across various sectors. However, this approach could also reduce the fund's overall yield, which is rebalanced quarterly. An ETF that tracks the index will likely be launched by mid-2006.
Hopefully, this article will provide you with a starting point for choosing the right dividend-oriented ETF for your portfolio. Fool on!
In addition to picking winning dividend-paying stocks in Motley Fool Income Investor, Mathew Emmert can make one-minute rice in 30 seconds. He owns none of the investments mentioned in this article. If you're more interested in buying individual dividend-paying stocks, try Income Investor free for 30 days. The Motley Fool isinvestors writing for investors.
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