Dividend exchange traded funds made a big splash in 2011 and most held up much better than the S&P 500 as investors were drawn to safety and income. Yet looking ahead to next year, there are increasing concerns that this strategy could be a “crowded” trade and that dividend ETFs may trail the market if stocks should rally.

The $9.3 billion iShares Dow Jones Select Dividend (NYSEArca: DVY) is up 10.6% this year, compared with a roughly 1% gain for the S&P 500, according to Morningstar. The fund’s top sector exposure is in utilities, which has helped in 2011 due to the sector’s outperformance.

SPDR S&P Dividend ETF (NYSEArca: SDY) also became an investor favorite in 2011. It tracks the S&P High Yield Dividend Aristocrats index, made up of 50 of the highest yielding companies in the S&P Composite 1500 constituents that have managed to increase dividends every year for the past 25 years. The fund has over $8 billion in assets. The ETF yields 3.6%. [Four Dividend ETFs with Growth Potential]

“A large portion of the returns from investing in stocks comes from dividends,” Morningstar says in a profile of the fund. “Standard & Poor’s Index Committee utilizes several screens that result in a higher quality, more-diversified portfolio than the naive strategy of simply buying 50 stocks with the highest yield.” [Dividend ETFs are Not All the Same]

SDY has the flexibility to include companies from all market capitalizations, and the weighting by yield allows plenty of small-cap value companies the chance to become part of the index. [Dividend ETF Gets Warm Reception in Europe]

Over 2011, the top 100 stocks in the S&P 500 with the highest dividend yields are up 3.7% on average, before dividends, reports Jonathan Cheng for The Wall Street Journal. In comparison, the 100 lowest-yielding stocks are down 10% on average. [ETF Chart of the Day: Dividend Funds]

The companies that are steady in payouts, or increasing their dividends, are usually going to produce decent returns over time, reports Amanda B. Kish for Motley Fool.

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