This is a blue blood exchange traded fund that has shed some quirkiness, but that has actually helped the fund stick to its game plan, writes Samuel Lee of Morningstar ETFInvestor.

At the end of June, Standard & Poor’s overhauled SPDR S&P Dividend’s (SDY) index for the better.

The S&P High-Yield Dividend Aristocrats Index used to demand 25 years of dividend growth, and was fairly liberal about letting in small-cap stocks, so you saw oddball holdings like United Bankshares (UBSI) rubbing shoulders with household names like Wal-Mart (WMT).

The problem was that as the fund grew into the billions, its trades started to affect stock prices. The financial crisis also winnowed the eligible universe to a very narrow group.

To fix these problems, S&P relaxed the index’s dividend-growth screen, now requiring only 20 years of annual dividend increases, and it upped the minimum market capitalization to $2 billion from $500 million. And it now holds all eligible constituents instead of the 60 highest-yielding.

The bad news is its yield will likely drop, because the fund isn’t as concentrated in the high yielders. But the benefits are more than worth it. Investors will pay less in implicit market impact costs. The changes also slightly reduce the fund’s tendency to load up on distressed stocks.

This is a decent fund for yield, and it just got a little better. It’s not our favorite dividend strategy, however. The crown still belongs to Vanguard Dividend Appreciation (VIG).

The fund holds all the stocks in the S&P 1500 that have raised their dividends every year for the past 20 years. It's a rarefied group—there are only 81 of them out of 1,500 names. Many of them are boring, quality names.

If a firm has grown its dividend like clockwork for 20 years, chances are it has solid earnings and a sustainable business model. It also signals a strong commitment to intelligent capital allocation. Management is less likely to engage in reckless capital spending if its goal is to protect and grow the dividend.
 
The fund’s yield-weighting produces an idiosyncratic portfolio with a strong mid-cap flavor. For instance, the $4.3 billion market-cap National Fuel Gas Company (NFG) has a greater weighting than the $410.8 billion Exxon Mobil (XOM). Consequently, the fund may occasionally move out of step with its large-cap value brethren.

If you’re OK with high tracking error relative to the market, this fund could be a decent core holding. For everyone else, this is a satellite holding. Regard­less of this distinction, we think dividend funds deserve the serious consideration of any investor, risk-averse or not.

Portfolio Construction
The fund tracks the S&P High Yield Dividend Aristo­crats Index: S&P 1500 stocks that have raised their dividends every year for the past 20 years. The stocks are weighted by yield, but capped at 4%.

The index reconstitutes annually in January, and rebal­ances quarterly. Historically, the index has turned over quite frequently despite rules to mitigate churn. In 2009, it turned over 105% of its portfolio, and in other years it has averaged around 40% turnover.

Fees
The fund charges a 0.35% expense ratio, in the typical range for a dividend strategy. The fund’s substantial stakes in less-liquid mid-cap stocks and its aggressive churn likely impose above-average trading costs for a fund in its category. However, the fund has lagged its index by only 0.16% annualized since its late 2005 inception to June 2012.

Like most State Street funds, SDY engages in securities lending, the practice of loaning out physical shares in exchange for a fee. State Street returns 85% of the resulting income to shareholders, an above-average cut of the proceeds. Counterparty risk should be modest provided State Street sticks to conservative industry practices.

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Tickers Mentioned: SDY, VIG, UBSI, WMT, NFG

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