Worried About a Pullback? Think Dividends

08/26/2013 9:00 am EST

Focus: STRATEGIES

Todd Rosenbluth

Senior Director of ETF & Mutual Fund Research, CFRA Research

For those concerned the market might pull back, one strategy worth considering is to shift money into dividend-focused investments; here are four dividend ETFs to weather a possible stock market drop, says Geoffrey Mrema and Todd Rosenbluth, of S&P Capital IQ.

We believe that when pullbacks happen, dividend stocks fare better than others because their yields provide downside protection.

While there are more than 100 stocks ranked by S&P Capital IQ as buy or strong buy that offer a 2.5% or greater yield, an ideal way for investors to get diversification to many of these stocks is through exchange traded funds (ETFs).

We ran a screen of the dividend-focused domestic equity ETFs with an Overweight ranking from S&P Capital IQ and a 12-month yield over 2.5%.

We excluded those ETFs that were focused on a specific sector, like utilities, since sector diversification provides its own benefits.

While S&P Capital IQ does not base ETF recommendations on yield alone, the consistency of dividend payments is a key component to the S&P Capital IQ Quality Ranking, which is a component of the risk considerations portion of our ranking methodology.

Our screen yielded seven results, and we chose the top four in terms of assets.

The SPDR S&P Dividend ETF (SDY) is the largest of the four. It owns companies that have increased dividends every year for at least 20 years. Its portfolio has 83 individual stocks with a median market capitalization of $13 billion.

On a sector basis, the fund's largest exposure is to consumer staples (18% of total assets), followed by financials (17%), and industrials (13%). For the year to date, the fund has attracted $1.3 billion in new cash, with $580 million coming in July according to IndexUniverse.

Vanguard High Dividend Yield Index Fund (VYM) is the second largest fund by assets, with holdings selected by its benchmark based on having the highest yields.

VYM holds 396 stocks and has an average market cap of just $3.1 billion, lower than the three other ETFs we profile. Its largest sector exposures are to consumer staples (17% of assets), followed by energy (13%) and industrials (12%). It has attracted $1.4 billion in inflows so far this year.

The iShares high Dividend ETF (HDV) has holdings that are chosen based on providing relatively high yields on a consistent basis, and it offers the highest overall yield of the four.

Its 77 stocks have a median market cap of $11.2 billion. The largest sector weightings are to health care (21%), consumer staples (18%), and telecom services (14%).

The smallest of the four ETFs is WisdomTree LargeCap Dividend Fund (DLN) which owns the 300 largest US dividend paying companies; their median market capitalization is $20 billion.

It is dividend weighted, to reflect the proportionate share of the aggregate cash dividends of each component company. Its largest sector weightings are in consumer staples (15%), information technology (14%), and financials (13%).

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