By SARAH MORGAN
In this still-shaky stock market, investors looking for yield and stability are turning to exchange-traded funds that track dividend-paying stocks. But not all dividend ETFs provide the bedrock investors may be expecting.
Dividend-paying ETFs have seen strong growth lately. Total assets in the 24 exchange-traded funds with "dividend" in their names have more than doubled in the past year, to $26.6 billion, according to fund tracker Morningstar. And as markets get rocky, the funds only look better to investors: In August, when volatility spiked, inflows to that group more than doubled compared to July, according to Morningstar.
Observers say the interest in the category isn't surprising. For one thing, Treasury and money-market yields are very low, which is helping to push income-focused investors towards dividend stocks, says Tom Lydon, the publisher of ETFTrends.com. Market swings also play a role, because dividend-paying stocks tend to be less volatile than the broader market, says Todd Rosenbluth, a fund analyst with Standard & Poor's. Some of the highest-yielding sectors in the S&P 500 are also the strongest performing sectors so far this year: While the S&P 500 as a whole yields 2.1% and was down 3.3% for the year as of Friday, utilities were yielding 4.2% and were up 8.4% for the year; consumer staples yielded 2.9% and had risen 5.2%; and health care stocks were yielding 2.2% and were up 4.8%. "We've seen investors gravitate towards companies that are perceived to be safer investments," Rosenbluth says.
But yield doesn't necessarily always equal stability. "If you just sort by dividend yield you tend to get companies that are in a distressed state," says Timothy Strauts, an ETF analyst at Morningstar. Mathematically, a dividend yield will rise if the stock price falls (because the yield is calculated as a percentage). For example, AllianceBernstein (AB)
Sector weights can also make a big difference in an ETF's performance. In 2008, many dividend-focused ETFs were more volatile than the broader market because of their high exposure to the financial sector, Strauts says. Financial services is now are a riskier sector than some of the other sectors where funds can find yield, because they're more sensitive to slow economic growth or recession than more defensive plays like utilities, consumer staples, or health care, Rosenbluth says. The WisdomTree Small Cap Dividend ETF (DES),
There are plenty of options for investors looking for a healthy dividend yield combined with a focus on defensive sectors. Strauts recommends the iShares High Dividend Equity ETF (HDV),
Dividend ETFs that focus on international or emerging market stocks generally have higher yields than U.S.-only funds. Stocks in other countries simply tend to pay higher dividends, Rosenbluth says. In general, emerging-market-dividend funds offer higher yields but are more volatile -- and more expensive -- than a U.S.-only dividend fund, he says. Compared to a general emerging-markets fund, however, they could be less volatile and see smaller losses in down markets, he says.
When looking internationally, investors should take a closer look at the holdings of funds with yields above 5%, Strauts says. Many international stocks pay dividends only once a year, and the most commonly used measures of a fund's yield take the most recent month's payment and annualize it, which for international ETFs could end up inflating the yield, Strauts says. Check the fund's 12-month yield for a truer picture of the payouts you'll see in a year, he says. Investors should also check the country weighting of international dividend funds, Strauts says, as these products may end up concentrated in one or two areas where dividends happen to be high. For example, the popular iShares Dow Jones International Select Dividend ETF (IDV)