Even in a rising interest rate environment, people will still seek out dividend stocks to generate yields. Exchange traded fund investors, though, can look to a targeted dividend strategy that specifically screens out areas vulnerable to rising rates.
For instance, the Fidelity Dividend ETF for Rising Rates (NYSEArca: FDRR) is designed to reflect the performance of stocks of large and mid-capitalization dividend-paying companies that are expected to continue to pay and grow their dividends and have a positive correlation of returns to increasing 10-year U.S. Treasury yields.
FDRR was designed to “reduce unintended exposure in sector bets,” Darby Nielson, managing director of research at Fidelity Management & Research Company, told ETF Trends in a call. “The ETF reduces exposure to utilities and REITs, sectors that really take it on the chin during rising rates.”
Looking at FDRR’s portfolio construction methodology, the underlying Fidelity Dividend Index for Rising Rates employs a multi-factor approach, including a 63% weight toward companies with higher dividend yields, and smaller 13.5% to avoid firms with payouts that are too high and might be cut in the future, 13.5% to those expected to grow dividends in the future and 10% to firms that perform better with rising rates.
FDRR’s main selling point is the ETF’s specific screens towards companies that perform well during rising interest rate environments.
“The strategy looks at every stock’s correlation to 10-year yield,” Darby said.
Consequently, in periods of rising rates, FDRR is neutral to stocks compared to other dividend ETFs that may weaken, essentially doing well on rising days and holding up on down slides to help investors generate improved risk-adjusted returns over the long haul.
FDRR’s additional focus on dividend growers may also help the portfolio perform during the period ahead as dividend growth stocks typically do well in rising rate environments.
“Dividend-yielding stocks are a heterogeneous group, and lower-payout, faster-growing dividend payers have historically held up well in rising-rate environments. Remember, over the long term, dividend-paying stocks have offered compelling returns relative to non-dividend paying stocks, and have done so with lower volatility,” Fidelity analysts said in a recent research note.
For more information on dividend stocks, visit our dividend ETFs category.