Amid expectations of rising Treasury yields, some high dividend exchange traded funds have been struggling this year. For example, the iShares Select Dividend ETF (NYSEArca: DVY), one of the largest U.S. dividend ETFs, is up barely more than 5% year-to-date, well off the pace set by the S&P 500.
DVY has a 3.00% 12-month yield. The Select Dividend ETF tracks the Dow Jones Select Dividend Index, which includes the highest-yielding 100 stocks from the Dow Jones that have paid annual dividends and showed dividend-per-share growth over the past five years.
However, DVY is starting to again benefit from its massive exposure to the suddenly hot utilities sector. That sector accounts for almost 31% of the ETF’s weight, more than double its second-largest sector allocation, which is consumer discretionary.
“DVY is uniquely positioned to benefit from rate hike delays because of its heavy exposure to the utilities sector. Utilities traditionally offer above-average yields and are known for their reliable revenue streams and, therefore, reliable dividends. This is not a new trend and will continue as long as rates stay low, which is continuing to be the case for longer than most market participants expected,” according to a Seeking Alpha analysis of the ETF.
Utilities are highly sensitive to interest rates. Additionally, the sector often trades at a premium to the broader market due to its high yield and defensive traits.
The fortunes of the utilities sector seem to be tied to the Federal Reserve’s interest rate outlook. Once the Fed eventually hikes interest rates, the higher rates will make fixed-income instruments more attractive on a relative basis, and bond-like equities, like utilities, less enticing. Consequently, utilities may remain flat or underperform other segments of the equities market once rates start ticking higher.
Related: Dividend ETFs for a Stubbornly Low-Yield Environment
While a rise in rates would diminish the attractiveness of dividend stocks with premium valuations and low growth, more high quality dividend payers or the group of dividend growers may stand out. DVY is levered to that theme with its cyclical exposure and by virtue of many of the ETF’s non-utilities holdings not being high-yield, but rather dividend growth ideas.
“Additionally, a cooling housing market presents another risk to DVY because of its utilities exposure. Importantly, the housing market has been improving for years, including a rise in home prices across the country, and an improving housing market could lead to higher electricity demand in developing areas, benefiting the utility companies that make up the bulk of DVY’s portfolio,” according to Seeking Alpha.
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Tom Lydon’s clients own shares of DVY.