Dividend stocks look like they could face an interesting environment through the rest of the year. The group briefly rode the cyclical rally over the past couple of months, but it looks like that has fizzled out, explains David Dierking, exchange traded fund expert and editor of The Street's ETF Focus.
Now, stocks are entering an environment where growth is slowing, inflation is high and the Fed has finally begun tightening conditions. In other words, it may not be the ideal time to be buying stocks.
But I've said that for a while and the S&P 500 just keeps pushing higher. We're entering what's traditionally been a favorable period for stocks and that could very well be the case again. The market seems to have a fairly good understanding of the Fed's intentions and that should help limit volatility.
WisdomTree U.S. MidCap Dividend ETF (DON)
When it comes to judging stocks by market cap, it's often framed in a "large-caps vs. small-caps" way. That leaves mid-caps out of the discussion altogether and that's a shame because up until just recently mid-caps have enjoyed better risk-adjusted returns than even the mighty S&P 500. DON is actually the 5th best performing dividend ETF so far this year with a gain of more than 28%.
Its definition of mid-caps is "...comprised of the companies that compose the top 75% of the market capitalization of the index after the 300 largest companies have been removed." From there, it weights by aggregate cash dividends distributed, which means instead of looking at growth histories or yields, it simply gives greater weights to companies that pay out the most cash.
My justification for choosing mid-caps? Large-caps have led for a long time and the rally looks like it's getting a little long in the tooth.
The economic environment may still favor large-caps since outperformance is fairly consistent with the idea of investors seeking safety within equities in a slowing growth economy, but I think we're due for a rotation away. With small-caps having been extra volatile but producing nothing in the way of excess gains, I'm going with mid-caps as middle ground between the two.
FlexShares Quality Dividend Index ETF (QDF)
QDF has had a relatively good year by dividend ETF standards having gained about 21%, but I still think this fund hasn't really gotten its due. I've banged the QDF drum for years, but it never seems to have gotten the kind of environment that's really checked all of its boxes.
It follows a quantitatively driven process that looks at things, such as strong cash flows, profitability and management efficiency and then weights the qualifying components by yield. It's a combination quality & high yield portfolio that should appeal to multiple groups of dividend seekers.
Risk-seeking behavior has been rewarded all year, but with the Fed finally beginning to tighten conditions, global growth slowing and the debt ceiling showdown soon to come, I think investors will need to be a little pickier in their dividend stocks. That means avoiding the pure yield grab and favoring stocks that are backed by better fundamentals.
The fund's yield would have previously stuck it in the high yield camp, but the latest yield is back down to just 1.8%, so it's now more of a pure quality play than anything. Tech is its top sector holding, but it's got a nice mix of cyclical and defensive holdings below that, so diversification is also a benefit.
VictoryShares U.S. Equity Income Enhanced Volatility Weighted ETF (CDC)
CDC is another great dividend ETF that flies under the radar because it doesn't come from one of the major issuers. It's not just one of the best-performing funds of 2021, up 28%, it's also one of the better long-term performers as well. It comes with a 5-star Morningstar rating, but with just $1 billion in assets, it doesn't get the credit it deserves.
CDC follows a similar idea to what I proposed with QDF, but it focuses more on low volatility than quality. Its portfolio construction is a little more complex though.
It starts by layering on a quality screen that only considers companies with at least 12 months of positive net earnings. From there, the 100 highest yielding stocks from its large-cap universe are selected with finally index weightings based on the inverse of the standard deviation of daily returns.
The screens are relatively loose, but the low volatility weighting methodology might be advantageous even though it hasn't performed well this year. CDC also yields 3% right now, so it will appeal to income seekers too.
Invesco High Yield Equity Dividend Achievers ETF (PEY)
Dividend growth has been the best-performing of the major income themes this year, but adding a high yield aspect to it has done even better. PEY tracks a dividend yield weighted index of the 50 names that have raised their dividends for at least 10 consecutive years.
This fund is perhaps one of the best combinations of dividend growth and high yield out there. The 10-year growth history requirement doesn't necessarily put all components in the dividend aristocrat category, but it's similar to the methodology used by the Vanguard Dividend Appreciation ETF (VIG).
Adding on the dividend-weighting component pushes a yield of 2% that you might get from the straight dividend aristocrat universe to more than 4% currently.
Virtus Real Asset Income ETF (VRAI)
VRAI is probably off of the radar for most dividend investors, but maybe they should reconsider because its portfolio is right in the wheelhouse of what's outperforming right now.
VRAI invests in a portfolio of real estate, natural resources and infrastructure stocks with a history of providing income and dividend growth, although it does not invest in hard assets or commodities directly.
Each real asset category consists of the top 30 dividend growers selected from the 60 highest dividend-paying securities in the category. In total, the fund contains 90 holdings that are weighted equally and rebalanced quarterly.
Among the familiar names in the fund, you've got Oneok (OKE), Valero Energy (VLO) and Pioneer Natural Resources (PXD). While the 3.7% yield right now is attractive, it's worth noting that the quarterly dividend can be a little choppy. The March dividend this year, for example, was $0.37, but the June distribution dropped all the way to $0.18.
