Dividend stocks endured some punishment earlier this year, but the related exchange traded funds are closing 2020 in strong fashion, indicating 2021 could bring better things for this beloved style of investing. That should bode well for the SPDR S&P Dividend ETF (NYSEArca: SDY).

SDY, one of the largest U.S. dividend ETFs, holds firms that have a minimum dividend increase streak of 20 years. Moreover, SDY follows a yield-weighting methodology that allocates a larger weight toward those with higher yields, so the portfolio leans toward more mid-sized companies. Historical data confirm that dividends are major contributors to investors’ long-term, total returns.

“Dividend-yield-weighting pulls this portfolio into the large-value category. However, this fund’s composition differs from most of its category peers,” notes Morningstar analyst Ryan Jackson. “The average market capitalization of its holdings is much smaller than the Russell 1000 Value Index, and its long dividend growth requirement precipitates some notable sector tilts, including heavy exposure to utilities firms and a relatively small stake in technology.”

Why SDY’s Value Tilt Matters

As income-minded investors look for ways to bolster returns in a low rate environment, various exchange traded funds can rise to the challenge.

Exposure to the value factor could be in play following rotation away from high growth that has outperformed this year to cheaper cyclical sectors. Value stocks tend to trade at a lower price relative to their fundamentals (including dividends, earnings, and sales).

SDY YTD Performance

While they generally have solid fundamentals, value stocks may have lost popularity in the market and are considered bargain-priced compared with their competitors. Value fans believe this time may be different for value stocks, pointing to improving investment sentiment measures, abating fears of a recession, rebounding corporate profits, and lessening trade tensions between the U.S. and China. Furthermore, value stocks are now trading at some of their most attractive prices in years as the growth/value gap is as wide as it’s been in decades.

Dividend-paying stocks can also help insulate investors from a broad market pullback. That’s particularly true of dividend growers, such as SDY components, which by virtue of their quality traits, tend to display less volatility in rough markets.

“Although its dividend-growth screen narrows the selection universe, this is a well-diversified portfolio. The top 10 holdings represented just 18% of this portfolio at the end of September 2020, and it caps investment at 4% for each firm. Sector risk is effectively diversified as well; no sector represents more than one fifth of the portfolio,” adds Morningstar.

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