Dividend ETFs and some traditional yield-producing sectors faced some pressure in November on expectations dividend tax rates will rise in 2013 as fiscal cliff negotiations look set to go down to the wire.
However, that doesn’t mean investors should automatically dump their dividend ETFs.
“The bottom line conclusion of our research is that the market environment is more important than the tax environment,” says Jeremy Schwartz, director of research at WisdomTree Investments (NasdaqGM: WETF)
Investors can also consider ETFs focusing on high-quality companies that also pay attractive dividends.
“Instead of investing in stocks that pay fat dividends, it may make more sense to consider why dividend-paying companies are so appealing — other than the payments themselves — and look for ways to invest in ones possessing such qualities,” writes Conrad de Aenlle for MarketWatch.
Reliable dividend payers are able to provide shareholders with extra pocket change because the companies have healthy cash-flow generation, he notes. The free cash flows would help with dividends, buybacks and reinvestment into the business.
It is the companies that provide value, not so much as the dividends have value. As such, the companies are worth owning in their own right and the dividend payments are just gravy, de Aenlle argues.
When it comes to dividends, companies have historically scaled back on payouts during periods of higher tax rates. In the periods when the highest tax rates on dividend income and long-term capital gains were equivalent, such as between mid-1980s through late 1990s and in the last decade, the number of companies that issued dividends was stable. However, the number of dividend-paying companies declined sharply when dividends were taxed at higher rates than long-term gains. [Dividend ETFs and the Fiscal Cliff]
One way for investors to gain exposure to high-quality companies that add value to shareholders without issuing dividends is through ETFs that follow the Morningstar Wide Moat Focus Index. The index tracks companies that have a sustainable and competitive edge in their industry.
The Elements Wide Moat Focus ETN (NYSEArca: WMW) has gained almost 50% over the past five years, compared to the 10% loss in the S&P 500. The recently launched Market Vectors Morningstar Wide Moat Research ETF (NYSEArca: MOAT) has increased 4.7% over the past three months while the S&P 500 added 1.0%.
Market Vectors Morningstar Wide Moat Research ETF
For more information on dividends, visit our dividend ETFs category.
Max Chen contributed to this article.