Sector Allocation Matters for Portfolio Dividend Yield | ETF Trends

Progressive financial advisors and investors have realized that a longtime popular stock market saying is not very accurate anymore, at least when it comes to investing for yield. That phrase is: “It’s not a stock market, it’s a market of stocks.” In other words, stock selection wins out over “owning the market.”

As it turns out, the truth is likely somewhere in between. When it comes to yield-driven portfolio management, sectors have taken a leading role versus generating “alpha” at the broad market or stock-specific level. The S&P 500 is divided into 11 different sectors via the Global Industry Classification Standard, the taxonomy system used by both S&P Dow Jones Indices and MSCI. For the opportunistic advisor or investor, these sectors represent 11 unique ways to drive dividend yield in a market where yield takes on a significantly different role than it has for about 15 years.

That’s because the Federal Reserve’s series of 11 interest rate hikes since 2022 have vaulted the yield available on U.S. Treasury bills to around 5%. That is more than three times the 1.5% yield of the S&P 500 Index. And it is getting the attention of investors.

So when it comes to the equity portfolio of a yield-oriented portfolio, the hurdle rate is suddenly much higher. T-bills are, for the first time in years, carrying a payout rate in the vicinity of 4%-5%. Further, such yields are creeping out along the Treasury curve. Three-year bonds currently yield over 4.8%, and even five-year notes are at 4.6%. That ups the ante for dividend stocks in an environment like the current one. Total returns have been hard to come by for anything that carries a yield.

Dividend Farming for Yield

The “Magnificent Seven” — Nvidia (NVDA), Meta Platforms (META), (AMZN), Microsoft (MSFT), Apple (AAPL), Alphabet (GOOGL), and Tesla (TSLA) — have dominated the U.S. stock market in 2023. That makes for a challenging environment for dividend investors.

Those huge tech stocks don’t yield much, if at all. And this might just be where sector allocation and pursuit of dividend yield come together like peanut butter and chocolate. By de-emphasizing what has just worked, refocusing on the quality implied by companies that pay out solid dividends, and taking more of a farming approach to cultivating dividend yield, investors might just be rewarded through an uneven stock market the rest of this decade.

The farming analogy works like this: Each of the 11 standard equity market sectors offers some stocks that are sufficient yielders for income investors and sell at valuations that don’t invite catastrophic risk. That is in stark contrast to the lower-yielding stocks, as was the case during the dot-com bubble, which has some similarities to today’s environment.

The ETF universe offers hundreds of dividend-focused funds. Some focus on stocks that have increased their dividend payment amount every year, such as the ProShares S&P Dividend Aristocrats ETF (NOBL). Others target the very-highest-yielding stocks, such as the SPDR Portfolio S&P 500 High Dividend ETF (SPYD).

Or it can be as straightforward as allocating evenly across sectors. In today’s market, that looks more attractive than it has in a while. Several sectors are selling at the upper end of their 10-year dividend yield ranges. Those include healthcare, consumer staples, financials, and basic materials. And since those sectors’ weightings in the S&P 500 and especially the Nasdaq-100 indexes pale in comparison to that of the tech sector, a neutralizing effect for sector exposure can instantly boost yield and improve valuation.

Dividend Dogs to the Rescue

An example is the ALPS Sector Dividend Dogs ETF (SDOG), an 11-year old, $1.1 billion fund. It seeks out the top-five-yielding stocks in each of the S&P 500 sectors, excluding REITs. That currently produces a portfolio that yields 4.5%. However, the stock mix has a forecasted yield of 5.3%, according to data from Ycharts. Furthermore, SDOG’s portfolio sells at 13.5X trailing 12-month earnings and 11.2X forward earnings. It also has a price to sales projection of less than 1X.

This all adds up to a combination of value, yield, and a built-in contrarian nature. And that’s largely because SDOG gives the sectors equal billing. In a market that is crowded at the top, SDOG is a decided step away from what has worked in the previous years toward what could lead in the years ahead.

SDOG’s sister fund, the ALPS International Sector Dividend Dogs ETF (IDOG), is structured the same way, but invests in non-U.S. stocks. The fund came on the scene a year after SDOG. That said – as with many international strategies — it has been more under the radar. Still, IDOG’s 60-stock portfolio sells at a mere 7X trailing earnings and yields 4.9%.

A quick look at the S&P 500’s paltry yield in the new era of 5% cash rates might cause some investors to look away from global equities for yield. But a slightly deeper dive reveals that portfolios can be constructed right now that offer competitive yields versus mega-cap-oriented funds, deep fundamental value, and an opportunity to use the current equity sector environment as a long-term total return opportunity.

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