iShares: The Impact of Rising Rates on Dividend ETFs

August 9th at 3:20pm by Dodd Kittsley -- iShares

The BlackRock Investment Institute recently published a new paper entitled Dividend Deluge, documenting the incredible surge in flows that dividend ETFs have experienced over the past few years.

With many yield-starved investors turning to dividend stocks as a way to cope with record low interest rates, equity-income focused ETFs have gathered $62 billion since January 2010, bringing the category to an impressive $87 billion in assets at the end of June.

Dividend deluge, indeed.  But what will happen to the growing number of ETFs in this category as rates continue their journey north?  It’s no secret that many investors have been using dividend stocks as a higher paying alternative to investment grade bonds.

In fact, flows into dividend ETFs have been closely tracking flows into investment grade bond ETFs since the beginning of 2010 (see below).  When bond interest rates climb higher again, will investors bolt on dividend ETFs as rapidly as they came in?

Our hypothesis: While there could certainly be a pullback in the category, we don’t expect continued rising rates to do lasting damage to dividend ETF growth.  There are a few reasons for this.  First, rates have already begun to rise this year  – the 10-year Treasury yield, for example, is currently up 100 basis points from its bottom.  And yet, year-to-date dividend ETF inflows of $16.7bn have shown no signs of abating, already topping their 2012 level ($14.5 billion) and on their way to breaking 2011’s record ($18.6 billion).

It’s also important to note that many investors see dividend stocks as a long-term, core investment versus a tactical play.  As my colleague Russ Koesterich pointed out in a recent post, research shows that over the long term, dividend stocks tend to outperform the broader equity market in both bull and bear markets.   Russ’s advice for a rising rate environment?  Don’t abandon dividend stocks, but be selective – he currently likes mega cap equities, energy sector and international dividend securities.

But perhaps most convincing is the faith that the ETF industry seems to have in the dividend stock category.  The number of dividend ETFs (166 at the end of June) has grown 75% year-to-date, outpacing the 57% increase in number of fixed income ETFs and the 37% increase in total ETFs created during the same time period.  Clearly, many ETF providers don’t see an end to dividend ETF demand any time soon.

With the vast number of choices that ETFs offer in the equity dividend category, it will be important for investors to do their due diligence to make sure they’re getting the exposure they desire.  But with this increased selection, chances are there will be a dividend ETF out there that’s right for each investor’s portfolio.

Dodd Kittsley, CFA, is the Head of Global ETP Market Trends Research for BlackRock.

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