The Federal Reserve hiked interest rates by a quarter of a point on Wednesday, and it looks like six more increases could be in the cards over the remainder of 2022.
Traditionally, rising interest rates are believed to be bad news for dividend stocks on the basis that as yields on lower risk government bonds climb, income investors will depart higher risk equities. However, that’s a broad assumption, and it doesn’t account for strategies that can prove durable as the Fed tightens.
Consider the WisdomTree US Quality Dividend Growth Fund (DGRW). As its name implies, DGRW’s objective is to deliver quality exposure. Looked at another way, this exchange traded fund isn’t heavily allocated to high-dividend names that can be vulnerable as rates rise.
“Industries that are generally deemed defensive in nature–owing to inelastic demand for their offerings and ample pricing power–tend to be negatively affected by changes in interest rates,” notes Morningstar’s Ben Johnson. “These include utilities and consumer nondurable goods. Companies operating in these industries tend to produce steadier cash flows and thus tend to suffer as rates rise and get a boost when they fall.”
DGRW has barely any exposure to utilities stocks, though consumer staples is its second-largest sector allocation at 19.62%. That said, consumer staples’ reputation for above-average dividends, steady payout growth, and below-average volatility could be appealing traits for investors in the current market climate.
DGRW sports a distribution yield of 1.47%. That’s not high, and it implies room for growth. Additionally, the fund’s status as a large-cap ETF — 96% of its holdings have market values north of $10 billion — is a favorable trait with interest rates moving higher.
“To better understand the relationship between dividend yields and interest-rate sensitivity, we need to connect the dots with companies’ fundamentals,” adds Johnson. “Dividends are often a sign of maturity. As companies progress through their life cycles, their growth slows and reinvestment needs decline, allowing them to distribute more cash. Using market cap as a proxy for maturity, this evolution is evident.”
Two more factors highlight the allure of DGRW this year, regardless of Fed plans. First, domestic dividends are expected to hit another record. Second, payout growth is usually a solid inflation-fighting tool. Plus, quality is always relevant.
“Rates will rise and fall, and no one knows when or by how much. Owning quality companies that regularly return cash to shareholders is a solid strategy for all rate environments,” concludes Johnson.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.