Broadly speaking, dividend exchange traded funds are outperforming the broader market this year, but investors still need to evaluate what’s driving that outperformance.
Typically, dividend ETFs fall into one of two categories: payout growth or high dividends/yield weighting. The latter category is winning this year, and as the Franklin U.S. Low Volatility High Dividend Index ETF (NASDAQ:LVHD) proves, adding the low volatility overlay to the mix is producing decent results for investors.
LVHD follows the QS Low Volatility High Dividend Index and is beating the S&P 500 by more than 1,200 basis points on a year-to-date basis.
“Yet the degree of outperformance has varied widely depending on the specific approach. The dividend investing strategies that have shone most brightly are those that hunt for dividend-paying companies that combine healthy balance sheets with hefty yields,” wrote Morningstar analyst Lauren Solberg.
High dividend strategies are often seductive, particularly in low interest rate environments, and although the Federal Reserve is raising borrowing costs, rates are still low by historical standards. However, some companies with big dividend yields could be dividend offenders because they lack the financial resources to adequately service those payouts.
Fortunately, LVHD’s underlying index potentially minimizes investors’ exposure to dividend offenders by factoring payout sustainability into the equation. Additionally, the index’s components are “scored higher or lower based on the attractiveness of their price and earnings volatility,” according to Franklin Templeton. In other words, some LVHD member firms have quality traits, and that’s a good thing for long-term dividend investors.
“Strategies with the quality focus are seeking profitable firms in position to sustain their dividends over many years, and slashing the companies that are paying dividends today but may not have the wherewithal to keep paying them in the future,” Morningstar analyst Ryan Jackson said. “They’re explicitly looking for clean balance sheets and strong profits: the kinds of things that put them in a position to keep the dividends flowing.”
About 54% of LVHD’s 99 holdings hail from the utilities, consumer staples, and real estate sectors. The fund’s outperformance of the broader market this year is being supported by small allocations to growth sectors, and that outperformance is all the more impressive when considering that LVHD has no exposure to energy, the best-performing sector in the S&P 500.
“Largely, the fate of dividend funds has come down to their sector exposures,” Jackson added. “Energy stocks have blown all the other sectors out of the water. Those tend to be much more prominent in dividend and value portfolios.”
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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.