A common criticism of exchange traded funds that track market capitalization-weighted benchmarks is that those funds are vulnerable to holding too many richly valued stocks because as a stock’s price increases, it takes on a larger role in cap-weighted indexes.
Scores of strategic beta ETFs attempt to skirt that issue and that is true of some dividend ETFs, including the WisdomTree Equity Income Fund (NYSEArca: DHS). DHS, which recently topped $1 billion in assets under management tracks the WisdomTree Equity Income Index (WTHYE). [WisdomTree Dividend ETF Tops $1B in AUM]
That index “is a fundamentally weighted index that measures the performance of companies with high dividend yields selected from the WisdomTree Dividend Index” and “is dividend weighted annually to reflect the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year, based on the most recently declared dividend per share,” according to WisdomTree (NasdaqGS: WETF).
The index’s methodology allows for underperforming stocks to see increased weights upon rebalancing while leaders are trimmed, giving investors a value tilt in the process. For example, the energy sector, currently one of the most deeply discounted groups relative to the S&P 500, is now DHS’ second-largest sector weight after being one of the ETF’s smallest allocations in 2014.
“The Energy sector deserves special note within WTHYE, because it added more than 8.6% to its weight as of the November 30, 2014, Index screening and became the third-largest sector represented. The mechanism driving this change was average sector dividend growth, coupled with below-average performance over the period, improving the relationship between dividends and price. Exxon Mobil Corp. was a noticeable addition to the Index with a maximum weight of 5.0%. Between annual screening dates, Exxon’s price declined 3.2%, but its dividends per share increased 9.5%, which increased its dividend yield 35 basis points (bps), from 2.63% to 2.98%1. Dividend yield is relevant to WTHYE because the Index first ranks eligible securities by dividend yields to screen the top 30% of the universe for inclusion before weighting them by their dividends,” said WisdomTree research analyst Tripp Zimmerman in a note out Wednesday. [A Relative Rebalance Case Study]
DHS’s underlying index also significantly ratcheted up its weights to other undervalued sectors, including consumer discretionary, which saw its weight in the ETF nearly triple to 7%. Industrials now account for 7.9% of the ETF’s weight up from 7% following the prior rebalancing.