Dividend ETFs Offer Mild Defense

Sunday, February 8, 2009

High-dividend stocks proved only mildly defensive during the first phase of the debt crisis, and it is instructive to consider the reasons. Beaten down considerably, this important asset class cannot be too far from the bottom and is still churning out all-important cash payments.

Dependant on earnings, dividends can be swept aside in an instant when a company is in distress. In 2008, 62 companies in the S&P 500 cut their dividends, and analysts believe more will follow in 2009. Total dividend payments are expected to decline 13% by Standard & Poor's, which would be the worst performance in 60 years. "Unless companies believe that their financial future will improve, their need to conserve cash will outweigh their desire to pay dividends", said S&P Index Services Howard Silverblatt in early 2009. The list of big companies slashing their dividends includes #1 department store Macy's and #3 cell phone manufacturer Motorola, as well as numerous financials.

Two out of four low-cost, broad-based US high-dividend stock ETFs bested the S&P 500 (SPY) in 2008.

SPDR S&P Dividend ETF (NYSEArca:SDY), with annual fees of 0.35% was the most volatile, while Vanguard Dividend Appreciation ETF (AMEX:VIG), with annual fees of 0.28% showed consistent strength. Highly correlated with the total market, Vanguard High Dividend Yield ETF (AMEX:VYM) with annual fees of 0.25% largely matched the market in 2008. WisdomTree Total Dividend ETF (NYSEArca:DTD), with annual fees of 0.28%, meanwhile, lagged notably.

Exposure to financials seems to explain much of the variation between these funds. DTD, for instance, contained more banks than any other sector in early 2009 at about 10%, even after precipitous declines in their valuations. In contrast, VIG held only 8% in financials by early 2009 and has much larger holdings in other sectors. Why were banks and insurance firms such a big presence in dividend ETFs? First of all they were a big presence in the US economy. At one point in 2007 they counted for over 1/5th of US stock market capitalization. More to the point for this asset class, they paid relatively generous dividends, so dividend ETFs overweighted them.

Curiously, some hard-hit ETFs are still spitting out attractive dividends. DTD, for instance, yielded about 6% in early 2009. But that number was held up more by a drop in stock prices in 2008 than by a hike in dividends. Better performing VIG sported only 3% yield by early 2009. To see how yield is propped up by price declines, consider the dividend yield equation:

Dividend Yield % = Dividend Payments / Stock Price

If the numerator (dividend payments) declines, the yield drops. But if the denominator (stock price) drops as well, yield will hold steady. Stock prices in fact often drop before dividends are actually reduced. Companies often resist dividend reductions for many quarters while earnings decline. All of this is quite public, and in anticipation savvy investors make their way to the exit door. Benjamin Graham, the father of fundamental stock analysis, often valued companies on the basis of their expected future dividend payments. When these are reduced or uncertain, valuations are sure to fall, he argued.

Happily, dividends are especially well-populated with ETFs. Credit goes mostly to WisdomTree, which specializes in this asset class. It points to studies suggesting that high-dividend stocks provide better risk-adjusted returns that low-paying ones. Its funds are also fairly priced, including niche areas, so investors pay little extra to overweight by region or company size. The serious dividend investor should investigate this line closely.

The following lists of ETFs are organized by category:

Size

  • WisdomTree Dividend Top 100 ETF (NYSEArca:DTN), annual fees: 0.38%
  • WisdomTree SmallCap Dividend ETF (NYSEArca:DES), annual fees: 0.38%
  • WisdomTree LargeCap Dividend ETF (NYSEArca:DLN), annual fees: 0.28%
  • WisdomTree MidCap Dividend ETF (NYSEArca:DON), annual fees: 0.38%

Fundamental

  • Invesco PowerShares Dividend Achievers ETF (AMEX:PFM), annual fees: 0.5%
  • Claymore/BBD High Income ETF (AMEX:LVL), annual fees: 0.6%
  • Invesco PowerShares High Yield Equity Dividend Achievers Portfolio ETF (AMEX:PEY), annual fees: 0.5%
  • WisdomTree DEFA High-Yielding Equity ETF (NYSEArca:DTH), annual fees: 0.58%

International

  • WisdomTree Emerging Markets High-Yielding Equity ETF (NYSEArca:DEM), annual fees: 0.63%
  • WisdomTree Emerging Markets SmallCap Dividend ETF (NYSEArca:DGS), annual fees: 0.63%
  • WisdomTree Europe Dividend ETF (NYSEArca:DEB), annual fees: 0.48%
  • WisdomTree Europe High-Yield Equity ETF (NYSEArca:DEW), annual fees: 0.58%
  • WisdomTree Europe SmallCap Dividend ETF (NYSEArca:DFE), annual fees: 0.58%
  • WisdomTree International Dividend Top 100 ETF (NYSEArca:DOO), annual fees: 0.58%
  • WisdomTree International LargeCap Dividend ETF (NYSEArca:DOL), annual fees: 0.48%
  • WisdomTree International MidCap Dividend ETF (NYSEArca:DIM), annual fees: 0.58%
  • WisdomTree International SmallCap Dividend ETF (NYSEArca:DLS), annual fees: 0.58%
  • WisdomTree Japan Dividend ETF (NYSEArca:DXJ), annual fees: 0.48%
  • WisdomTree Japan High-Yield Equity ETF (NYSEArca:DNL), annual fees: 0.58%
  • WisdomTree Japan SmallCap Dividend ETF (NYSEArca:DFJ), annual fees: 0.58%
  • WisdomTree Middle East Dividend ETF (AMEX:GULF), annual fees: 0.88%
  • WisdomTree Pacific ex-Japan Dividend ETF (NYSEArca:DND), annual fees: 0.48%
  • WisdomTree Pacific ex-Japan High-Yielding Dividend ETF (NYSEArca:DNH), annual fees: 0.58%
  • SPDR S&P International Dividend ETF (NYSEArca:DWX), annual fees: 0.45%
  • Claymore/AlphaShares China Small Cap ETF (AMEX:HAO), annual fees: 0.7%

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.