A Dividend ETF That Beats Rising Rates

December 31st at 9:30am by Todd Shriber

Although U.S. stocks soared in 2013, one of the more prominent themes facing investors was the specter of rising interest rates.

With confirmation of the Federal Reserve’s intent to taper its quantitative easing program and 10-year Treasury yields hovering near 3%, higher rates in 2014 appear to be a foregone conclusion. That could spell bad news rate-sensitive sectors previously prized by income investors due to steady dividends and robust yields. Think telecom and utilities, which have already shown their vulnerability to higher rates in 2013. [Low Expectations for Utilities ETFs]

While most multi-sector U.S. dividend ETFs are not heavily allocated to the telecom sector, many do boast heavy allocations to utilities and/or consumer staples. Those two sectors are not only rate-sensitive, but are also trading at premium valuations. [A Long-Term Perspective on Sector Investing]

Income investors opting for ETFs can skirt large allocations to those sectors with the FlexShares Quality Dividend Dynamic Index Fund (NYSEArca: QDYN). QDYN debuted just over a year ago as part of three-ETF suite of dividend funds from FlexShares. The FlexShares Quality Dividend Index Fund (NYSEArca: QDF) has proven to be the most successful of that trio, at least terms of assets accumulated.

QDF has $328 million in assets under management while QDYN has just under $20 million. However, QDYN’s diminutive stature belies its utility as a valid rising rates play. QDYN, which uses a higher beta approach than QDF, has a mere 9% weight to utilities and telecom, has a weighted average dividend yield of almost 3.2%. For now, that is attractive relative to 10-year Treasuries. [Rising Rates Have Turned These Dividend ETFs Into Laggards]

QDYN, unlike many of its dividend ETF rivals, is also light on the consumer staples sector. That group is just 6.6% of the ETF’s total weight and there are just two staples names found among the ETF’ top-30 holdings.

QDYN’s holdings “are selected based on expected dividend payment and fundamental factors such as profitability, solid management, and reliable cash flow,” according to FlexShares.

Here is the tale of the tape: Treasury yields have surged this year, that is a known fact. That has not stopped the Vanguard High Yield Dividend ETF (NYSEArca: VYM) from gaining 29.9%. QDYN, however, has gained 33.4%, rendering the 27-basis point difference in expenses in favor of VYM a moot point.

FlexShares Quality Dividend Dynamic Index Fund