Dividend ETF Investing: Mid-Cap Options

The universe of U.S.-listed exchange-traded products has grown at an impressive rate over the last several years, bringing the industry to a point where there are more than 1,100 products with aggregate assets exceeding $1 trillion. According to the ETF screener, there are nearly 800 equity ETFs available, an impressive total that allows investors to slice and dice global stock markets in a number of different ways.

Many of the most popular equity ETFs are broad-based "plain vanilla" products that offer exposure to benchmarks such as the S&P 500, Russell 1000, or the MSCI Emerging Markets Index. But the ETF product lineup also includes various options that deliver more targeted exposure, allowing investors to fine-tune equity allocations by gaining access to various sectors, countries, and weighting methodologies [see Do You Need a RAFI ETF?].

There are also ETFs offering exposure to numerous investment strategies and methodologies, including funds that take a contrarian approach (JCO), focus on companies that have been spun off (CSD), invest in recent IPOs (FPX), and use insider sentiment and trading patterns to determine holdings (NFO). The list goes on, but one especially popular investing strategy available through ETFs focuses on dividends -- specifically targeting stocks of companies that have a history of consistently paying or increasing dividends.

Dividend ETFs may be appealing for a number of reasons. With interest rates near record lows and expected to remain depressed for the foreseeable future, some investors have embraced dividend-paying stocks as a tool for enhancing the current return of their portfolios. Dividend ETFs can also be useful for investors looking to scale back risk slightly while still maintaining exposure to equities. Bigger dividends usually translate into lower volatility, making dividend ETFs potentially attractive for investors looking to dial back risk without going the extreme of swapping out stock exposure for fixed income securities or cash.

Mid-Cap Options
While there are a number of ETF options offering exposure to dividend-paying ETFs, many of these products focus exclusively or primarily on large cap stocks -- because the biggest companies will often have the most substantial dividends, companies such as ExxonMobil, AT&T, Pfizer, and Verizon often receive big allocations in indexes designed to include domestic dividend paying companies.

Exposure tilted towards large caps may be desirable for certain investors, but others may wish to go beyond the largest companies and achieve exposure to smaller dividend-paying equities. Dividend-paying mid caps present an interesting investment option, as these securities may offer many of the benefits of investing in mega caps -- strong cash flows and a stable business model -- while offering some of the attractive features of smaller companies as well. "Investing pros say mid-sized companies that pay dividends may be a better bet than the giants," writes Sarah Morgan. "There's also added potential for faster growth, traditionally a reason investors like mid-cap stocks in general."

Another attractive element of DON is the depth of holdings; no single company makes up more than 1.5% of holdings, and the top 10 holdings make up only about 12% of assets. That structure avoids concentration of exposure in a single stock or a handful of companies -- something that isn't always the case for dividend ETFs that tilt towards large-cap stocks.

Not surprisingly, DON has a heavy tilt towards certain sectors that tend to pay attractive dividends; REITs make up about 22% of holdings, followed by utilities (17%) and financial services firms (16%).

WisdomTree International Mid Cap Dividend Fund (NYSE: DIM)
This ETF is the international counterpart to DON, seeking to replicate an index that measures the performance of the mid-capitalization segment of the dividend-paying market in the industrialized world outside the U.S. and Canada. Similar to DON, this fund avoids concentration in any one name; DIM has more than 300 individual holdings, and no one stock accounts for more than 1.5% of portfolio assets. The sector biases, however, are a bit different; DIM is tilted towards industrials (23%), financials (18%), and consumer cyclicals (15%).

The underlying index maintains a dividend yield of about 4.3%, an impressive current return metric. The price/cash flow of the related benchmark is less than 9x, while P/E was recently hovering around 16 times. The 30 day SEC yield on DIM was recently around 3.2%, while the distribution yield comes in at 2.4% [see How to Find the Right Dividend ETF].

DIM focuses on developed markets, but spreads exposure across a number of different regions. The U.K., Japan, and Australia are the three largest country allocations, combining to account for nearly 50% of assets.

Rydex S&P MidCap 400 Pure Value ETF (NYSE: RFV)
There are also a number of products that bifurcate stock markets based on investment style, splitting the universe into growth and value subsets. Growth companies are generally those that exhibit higher pricing multiples (such as price-to-earnings, or P/E) and lower dividends, with the opposite true of value stocks. There is a fair amount of evidence suggesting that different types of companies may perform better in certain economic environments, and the unique risk/return profiles of each may be useful.

Several ETFs offering exposure to mid cap value stocks, but many are linked to indexes that throw around "value" and "growth" classifications quite liberally. RFV and its growth counterpart RFG are part of a suite of Rydex ETFs that implement strict screens for value and growth companies, offering exposure only to companies that exhibit the strongest characteristics of the relevant investment style. While the iShares S&P MidCap 400 Value Index Fund (NYSE: IJJ) has about 300 individual holdings, RFV has only 100 or so [see For ETF Investors, the Details Matter].

While RFV doesn't focus explicitly on dividend payers like DON does, its underlying index has a tendency to include the companies exhibiting strong value characteristics -- including above average dividend yields. RFV doesn't come close to matching the dividend yields or other current return metrics of DON or DIM, so those focusing solely on those features might take a pass. But for those looking to establish a more general value tilt, this fund might be worth a closer look [use the Head-to-Head ETF Comparison Tool to see how RFV and DON stack up in terms of expenses, performance, and holdings].

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Disclosure: No positions at time of writing.

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