Don't Rely on the Same Old Sectors With Dividend ETFs | ETF Trends

The $443.49 million FlexShares Quality Dividend Defensive Index Fund (NYSEArca: QDEF) is nearly eight years old, but it offers one of the fresher approaches in the world of dividend ETFs and that’s meaningful at a time when old guard dividend methodologies aren’t delivering like they used to.

FlexShares’ quality dividend indexing methodology targets management efficiency or quantitative evaluation of a firm’s deployment of capital and its financing decisions. By using a management efficiency screen, the index can screen out firms that aggressively pursue capital expenditures and additional financing, which typically lose flexibility in both advantageous and challenging partitions of the market cycle.

“Historically, high dividend-paying companies tend to be focused in mature indus­tries and hence tend to be concentrated in certain sectors,” said FlexShares in a recent note. “Our research suggests that half of the MSCI World Index dividend yield is contributed by four sectors: Financials, Industrials, Consumer Discretionary, and Energy. Consequently, we believe many high-dividend strategies have historically focused on high-income payers that may result in significant sector and regional bets and may concentrate the source of dividends in an effort to achieve income objectives.”

Those sectors combine for less than a third of QDEF’s roster.

QDEF Stands Out

“Relying heavily on one sector for dividends can be a recipe for disaster, as was observed during the Global Financial Crisis in 2008 when companies within the Financial sector experienced a dividend reduction of 60%,” according to FlexShares. “In the current environ­ment, according to Bloomberg, as of 31 March 2020, high-dividend payers are sourcing two-thirds of their yield from the four sectors where we believe dividends are most at risk.”

While its allocation to once beloved but now disappointing dividend sectors is relatively light, QDEF devotes over 38% of its weight to the technology and healthcare sectors – two groups that are actually delivering payout growth this year. What’s meaningful about QDEF’s technology and healthcare exposure is that it translates to quality and that benefits long-term investors.

“We argue that investors should take a ‘Quality Plus Approach’ which is to consider companies that have sustainable competitive advantages and have generated sustainable shareholder value over time. Information on a firm’s ‘Quality Plus’ may help assess the sustainability of payouts by measuring characteristics including strong profitability, consistent and strong levels of cash flows, and prudent deploy­ment of capital by an efficient management team to arrive at a Dividend Quality Score (DQS),” notes the issuer.

The Dividend Quality Score process is designed to maximize quality and yield while putting several diversification controls into effect through its selection and weighting process. FlexShares’ multi-faceted dividend quality score examines companies based on three factors when determining its dividend quality indexing methodology.

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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.