Dividend ETFs are in demand, but will their payouts hold up?

Investors continue to embrace all sorts of exchange-traded funds, but they're throwing a bear hug around dividend-paying ETFs. This fall dividend-paying ETFs as a group had $24 billion in assets, over 50% more than at the start of 2010, and it's currently the fastest growing ETF category, according to State Street Global Advisors. But just because these ETFs have the word "dividend" in their name doesn't guarantee big, fat, dependable payouts.

Indeed, analysts say some ETFs look like the stock market equivalent of junk bonds. They hold stocks that have robust yields but that might have trouble maintaining the high payouts. PowerShares High Yield Equity Dividend Achievers ETF (PEY) has a 4.2% yield, more than double the about 2% yield of the broader Standard & Poor's index, but nearly a third of its holdings are financial stocks that, thanks to the ongoing real estate mess, could face problems. Two holdings, Mississippi-based BancorpSouth (BXS) and Los Angeles insurer Mercury General (MCY), have yields of more than 5%, but both were recently downgraded by credit-rating agencies. BancorpSouth and Mercury General declined to comment. Invesco PowerShares says it boots a stock out of its ETF if the company cuts its dividend.

Investors who want more-traditional payers could look to the Vanguard Dividend Appreciation ETF (VIG), whose top holdings include PepsiCo (PEP) and other firms with a history of raising dividends, says Dena Minning, a Treasure Island, Fla., financial adviser who uses the fund with clients. But that ETF has a yield only about 0.1 percentage point higher than the SPDR S&P 500 (SPY) . The Vanguard ETF also has higher annual expenses than the vanilla S&P ETF. That's the cost of safety, some advisers say. "When things get ugly, it should go down less than the Standard & Poor's 500," says Herb Morgan, president of Efficient Market Advisors, a Del Mar, Calif. based financial-planning firm.