This Year’s Leading Dividend ETFs Could Face Headwinds in 2015

The utilities sector is the second-best performer in the S&P 500 this year behind health care and the stodgy, high-yielding sector’s rise has been a boon for an array of utilities-heavy dividend exchange traded funds.

However, investors should exercise some caution if they are expecting this year’s surges by defensive sectors to repeat in 2015, particularly if interest rates rise. Noting that investors’ appetite for income and yield has not been limited to real estate investment trusts (REITs), also a rate-sensitive asset class, BlackRock Chief Investment Strategist says in a note posted by Barron’s, “We see a similar appetite for defensive sectors of the stock market, notably utilities and consumer staples. While the thirst for yield is understandable, it may be leading investors to overpay and take on hidden risks.”

On Monday, 160 ETFs hit all-time highs and of that group, 20 were dividend ETFs. Of that group of 20, several were utilities- heavy ETFs. That confirms the notion these ETFs, several of which also feature large allocations to the consumer staples sector, have enjoyed this year’s almost 24% decline by 10-year Treasury yields. [Utilities Drive This Dividend ETF]

Familiar dividend ETFs on Monday’s all-time high list include the iShares Select Dividend ETF (NYSEArca: DVY), iShares Core High Dividend ETF (NYSEArca: HDV) and the WisdomTree Dividend ex-Financials Fund (NYSEArca: DTN).

DVY, one of the largest U.S. dividend ETFs, allocates 35% of its weight to utilities stocks while HDV devotes 35% of its combined weight to staples and utilities. DTN, which holds no financial services stocks, also allocates nearly 35% of its combined weight to consumer staples and utilities names. [A Dividend ETF That Likes Low Interest Rates]

Led by DTN’s 11% year-to-date gain, all three are up at least 10% this year, but that does not mean these are risk-free bets if interest rates rise next year. Not only that, but defensive staples and utilities are not synonymous with value.

“The defensive sectors all sport aggressive valuations and carry hidden duration, or interest rate sensitivity. If interest rates rise even modestly in 2015 — as we expect they will — these sectors are likely to perform poorly, as their valuations are particularly sensitive to rate rises,” said Koesterich.

A growing number of dividend ETFs offer income investors to cyclical sectors that historically perform well when interest rates while featuring reduced exposure to utilities names. Some of those ETFs, including the iShares Core Dividend Growth ETF (NYSEArca: DGRO) and the WisdomTree U.S. Dividend Growth Fund (NasdaqGM: DGRW), also hit new highs on Monday.

DGRO, which is nearing $100 million in assets under management, making it one of this year’s most successful new ETFs, is staples-heavy but devotes less than 5.7% of its weight to utilities stocks. [Another Decent Year for New ETFs]