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The Best Dividend ETF: Data-Driven Answers


Charlie Munger has a fitting analogy for investing markets; racetrack betting.

“The model I like to sort of simplify the notion of what goes on in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based o­n what’s bet. That’s what happens in the stock market.”

Only the very best horses are remembered. Names like Secretariat and Sea Biscuit are famous.

We have a fascination with the best. That’s because the best wins. This is just as true in investing as it is in horse racing.

It is not easy to determine the best beforehand in horse racing or in the stock market. That’s where the semi-famous disclaimer “past performance is no guarantee of future success” comes from.

This article takes a look at what the best dividend ETF available is. To determine “the best”, historical performance all dividend ETFs with over $1 billion in assets under management that were created prior to 2007 is compared.

Horse Race Image

This is backward-looking analysis. ETFs capture particular investing styles and methods. The stock selection method (presumably) does not change. In this way, we can determine what style of dividend ETF has historically outperformed – and what style has the highest likelihood of continuing to do so.

Past performance is no guarantee of future success, but it sure doesn’t hurt. I’d much rather have my money with a manager who has a historical record of outperformance (like Warren Buffett) than someone who as a historical record of losing money hand-over-fist.

In addition to performance comparisons, this article takes a look at several dividend ETF screens and lists so you can quickly find dividend ETFs worth your time and money.

It also takes a look at the pros and cons of buying dividend ETFs versus investing in individual dividend stocks. There is more to this decision than first comes to mind.

I divide the dividend ETF universe into 4 broad categories to determine performance:

The ‘Traditional’ category contains dividend ETFs that do not fall into the growth, high yield, or international categories.

The ‘Growth’ dividend ETF category contains dividend ETFs that are focused on growth or rising dividend income.

The ‘High Yield’ dividend ETF category contains dividend ETFs that invest primarily for high yield.

Finally the ‘International’ dividend ETF category contains dividend ETFs that invest primarily in international (non US) dividend stocks.

There is significant overlap in the categories. Distinctions were made as best as possible.

The Best Traditional Dividend ETF

There are 5 Dividend ETFs in the traditional category with more than $1 billion in assets under management.
 

Name Symbol
AUM
Expense Ratio Dividend Yield
iShares Select Dividend ETF DVY $14.1 billion
0.39%
3.4%
Wisdom Tree Large Cap Div. DLN $1.7 billion
0.28%
2.9%
Wisdom Tree Mid Cap Dividend DON $1.5 billion
0.38%
2.6%
First Trust Value Line Div. Income FVD $1.4 billion
0.70%
2.3%
First Trust Morningstar Div. Leaders FDL $1.1 billion
0.45%
3.6%

Note: AUM stands for assets under management.

The iShares Select Dividend ETF is by far the largest of the group based on its assets under management.

The Schwab U.S. Dow Jones Dividend 100 ETF is the least expensive with an absurdly low expense ratio of just 0.07% a year.

The performance of all 5 of the traditional dividend ETFs is shown below. They are all compared against the SPDR S&P 500 ETF (SPY) to show relative performance.

Traditional ETF PerformanceNote: Returns include dividend payments

The Wisdom Tree Mid Cap Dividend Fund and the First Trust Value Line Dividend Income ETFs both outperformed the S&P 500 from 2007 through March 9th, 2016. The table below shows performance statistics.
 

Symbol CAGR Standard Deviation Sharpe Ratio
SPY 6.0% 21.5% 0.24
DVY 5.0% 21.6% 0.20
DLN 5.2% 20.6% 0.22
DON 7.3% 23.7% 0.28
FVD 7.4% 18.8% 0.36
FDL 4.7% 22.4% 0.18

Notes: CAGR stands for compound annual growth rate. Standard deviation is the annualized price standard deviation from 2007 through 3/9/16. Sharpe ratio uses a risk free rate of 0.7% which is the average US 3 Month T-Bill yield for the time frame of the study.

The financial ratios and metrics above show a clear winner – The First Trust Value Line Dividend Income ETF (FVD).

FVD outperformed the market by 1.4 percentage points a year while also having a lower price standard deviation of 18.8% versus 21.5% for the S&P 500. As a result FVD has a superior Sharpe ratio of 0.36 versus 0.24 for the S&P 500.

The question is why did FVD outperform?

FVD seeks to track the Value Line Dividend Index. The Value Line Dividend Index is constructed as follows:

  1. The index begins with the universe of stocks that Value Line® gives a SafetyTM Ranking of #1 or #2 using the Value Line® SafetyTM Ranking System. All registered investment companies, limited partnerships and foreign securities not listed in the U.S. are removed from this universe.
  2. From those stocks, Value Line® selects those companies with a higher than average dividend yield, as compared to the indicated dividend yield of the Standard & Poor’s 500 Composite Stock Price Index.
  3. Value Line® then eliminates those companies with an equity market capitalization of less than $1 billion.
  4. The index seeks to be equally weighted in each of the securities in the index. The index is rebalanced on the application of the above model on a monthly basis.

Source: First Trust

FVD is an equally weighted basket of higher-than-average yielding dividend stocks with a market cap over $1 billion and a safety ranking of #1 or #2 from Value Line.

Two factors separate FVD from the other dividend income funds:

  1. It is the only equally weighted fund above
  2. It uses Value Line safety scores

Equally weighting a portfolio has been shown to historically outperform market cap weighting. Proof of this is in the slight outperformance of the equally weighted S&P 500 Index versus the traditional market cap weighted index.

Source: Guggenheim S&P 500 Equal Weight Fact Sheet

Equally weighting alone does not fully explain the FVD ETF’s outperformance. FVD has also outperformed RSP since 2007:

The Value Line Safety scores must have some casual effect on FVD’s outperformance. Here’s what Value Line has to say about their safety scores:

“Safety is a quality rank, not a performance rank, and stocks ranked 1 and 2 are most suitable for conservative investors; those ranked 4 and 5 will be more volatile. Volatility means prices can move dramatically and often unpredictably, either down or up.

The major influences on a stock’s Safety rank are the company’s financial strength, as measured by balance sheet and financial ratios, and the stability of its price over the past five years”

From this, it appears that Value Walk’s safety scores are calculated from:

5 year stock price standard deviation is likely another reason for this funds outperformance. Low volatility stocks have historically outperformed the market. The S&P Low Volatility index outperformed the S&P500 by 2.00% per year for the 20 year period ending September 30th, 2011. Stock price standard deviation is covered in Rule 5 of The 8 Rules of Dividend Investing.

The financial strength indicators certainly wouldn’t hurt performance, but how they are calculated is very vague. Most if not all of the outperformance of FDV can be attributed to:

  1. Investing in low volatility dividend stocks
  2. Equal weighting these stocks in the portfolio

Dividend Growth ETF Performance Comparison

Dividend growth ETFs are categorized by their focus on growth and rising dividends as opposed to ‘all dividend stocks’ or ‘high yields’. There is only one dividend growth ETF with more than $1 billion in assets under management. It is listed below along with key stats
 

Name Symbol AUM Expense Ratio Dividend Yield
Vanguard Dividend Appreciation ETF VIG $22.9 billion 0.10% 2.4%

The Vanguard Dividend Appreciation ETF holds $22.9 billion in assets. It also has a minuscule expense ratio of just 0.1%. The Vanguard Dividend Appreciation ETF’s performance from 2007 through March 9th, 2016 versus the S&P 500 SPDR (SPY) is shown in the chart and table below:

VIG vs SPY
 

Symbol CAGR Standard Deviation Sharpe Ratio
SPY 6.0% 21.5% 0.24
VIG 6.4% 18.6% 0.31

Notes: CAGR stands for compound annual growth rate. Standard deviation is the annualized price standard deviation from 2007 through 3/9/16. Sharpe ratio uses a risk free rate of 0.7% which is the average US 3 Month T-Bill yield for the time frame of the study.

VIG has outperformed the S&P 500 since 2007 – with a lower price standard deviation. As a result, this dividend ETF has a higher Sharpe Ratio than the S&P 500.

What’s interesting about this outperformance is when it occurs. The chart above shows that VIG tends to outperform SPY during bear markets and recessions, while SPY tends to outperform during bull strong bull markets.

VIG tracks the Dividend Achievers Index. To be a Dividend Achiever, a stock must match the following criteria:

 

The index is not equally weighted. The outperformance of VIG over SPY likely comes from investing in superior businesses.

Businesses that can pay increasing dividends for 10+ consecutive years very likely have a competitive advantage that can be leveraged to provide real business growth. A strong competitive advantage also reduces risk – which is reflected in the lower stock price standard deviation of VIG.

This type of business will typically perform better during recessions as their competitive advantages insulate earnings. They tend to slightly underperform during bull markets as businesses that aren’t as strong make up more ground faster because operations fell further during the previous bear market.

High Yield Dividend ETF Performance Comparison

The defining characteristic of a high yield dividend ETF is its focus on (as you might have guessed) high yielding stocks. This is determined by the funds’ stated goal, not its actual dividend yield.

The table below shows the 2 high yield dividend ETFs that have more than $1 billion in assets under management.
 

Name Symbol AUM Expense Ratio Dividend Yield
SPDR S&P Dividend ETF SDY $12.7 billion 0.35% 2.5%
Vanguard High Dividend Yield ETF VYM $15.6 billion 0.09% 3.3%

Both funds are large with over $10 billion in assets under management. VYM has an exceptionally low expense ratio of 0.09% – less than 10% of the average equity mutual funds’ expense ratio.

The table and chart below compare these two ETFs to each other and to the S&P 500 SPDR (SPY).

High Yield ETF Performance
 

Symbol CAGR Standard Deviation Sharpe Ratio
SPY 6.0% 21.5% 0.24
SDY 6.8% 21.9% 0.28
VYM 6.1% 20.2% 0.27

Notes: CAGR stands for compound annual growth rate. Standard deviation is the annualized price standard deviation from 2007 through 3/9/16. Sharpe ratio uses a risk free rate of 0.7% which is the average US 3 Month T-Bill yield for the time frame of the study.

Both funds outperformed the S&P 500 (with VYM just barely doing so) on a total return basis. Both also outperformed based on the Sharpe Ratio.

SDY outperformed but also had a higher stock price standard deviation which is unusual considering dividend stocks tend to have lower stock price standard deviations on average.

SDY’s fund objective is:

“The SPDR® S&P® Dividend ETF seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P® High Yield Dividend AristocratsTM Index.”

The S&P High Yield Dividend Aristocrats Index is not the same as the Dividend Aristocrats Index. It is similar, however. The S&P High Yield Dividend Aristocrats Index has the following characteristics:

SDY is therefore weighted toward:

  1. High yield stocks
  2. With long streaks of rising dividends

We know from the Dividend Achievers Index and the Dividend Aristocrats Index as well as their fairly close constituent make up to low volatility indexes that businesses with long dividend streaks tend to have lower than average stock price volatilities.

The higher stock price standard deviation of SDY must therefore come from its heavy weighting toward higher yield stocks.

The outperformance of the index is likely due to its weighting toward high quality businesses with long dividend streaks, not its weighting toward high yield stocks in general.

International Dividend ETF Performance Comparison

There is only 1 international dividend ETF with more than $1 billion in assets under management and price data back to January of 2007.
 

Name Symbol AUM Expense Ratio Dividend Yield
Wisdom Tree Int’l Small Cap Dividend DLS $1.0 billion 0.58% 2.9%

The Wisdom Tree International Small Cap Dividend ETF (DLS) has all the makings of a very interesting ETF. It provides international exposure in combination with small cap investing and dividends.

Unfortunately, its performance has not lived up to expectations thus far.

DLS vs SPY
 

Symbol CAGR Standard Deviation Sharpe Ratio
SPY 6.0% 21.5% 0.24
DLS 2.3% 22.1% 0.07

Notes: CAGR stands for compound annual growth rate. Standard deviation is the annualized price standard deviation from 2007 through 3/9/16. Sharpe ratio uses a risk free rate of 0.7% which is the average US 3 Month T-Bill yield for the time frame of the study.

Part of the underperformance can be blamed on the strength of the United States dollar recently, but this does not account for all of the underperformance.

The ETF tracks dividend paying small caps in the developed world (excluding the United States and Canada). This ETF is heavily weighted toward European small caps, with Japanese small caps also making up 27% of the portfolio. Europe and Japan are mired in debt and are experiencing anemic growth. Perhaps this weakness is reflected in the small cap dividend stock performance from Europe and Japan.

The Best Dividend ETF Is…

The table below summarize all the Dividend ETFs analyzed in this article.
 

Symbol CAGR Standard Deviation Sharpe Ratio
SPY 6.0% 21.5% 0.24
FVD 7.4% 18.8% 0.36
VIG 6.4% 18.6% 0.31
DON 7.3% 23.7% 0.28
SDY 6.8% 21.9% 0.28
VYM 6.1% 20.2% 0.27
DLN 5.2% 20.6% 0.22
DVY 5.0% 21.6% 0.20
FDL 4.7% 22.4% 0.18
DLS 2.3% 22.1% 0.07

Notes: CAGR stands for compound annual growth rate. Standard deviation is the annualized price standard deviation from 2007 through 3/9/16. Sharpe ratio uses a risk free rate of 0.7% which is the average US 3 Month T-Bill yield for the time frame of the study.

There is clearly something to dividend investing. Five out of the 9 funds analyzed outperformed the S&P 500 in the period analyzed.

The single best performing dividend ETF was FVD, followed by VIG.

Both ETFs have something in common…

They invest in high quality dividend paying stocks. They don’t chase yield. FVD is superior to VIG in that it also equally weights its portfolio.

Investors looking for dividend ETFs should invest in funds that prioritize quality and safety over high yields. The historical record speaks to the efficacy of this approach.

Both FVD and VIG had higher total returns than the S&P 500 with lower price volatility. This is a rare combination that is very valuable for investors seeking to maximize risk adjusted returns.

It is interesting to note that Warren Buffett’s portfolio is heavily invested in similar high quality dividend stocks.

Other Dividend ETFs Worth Mentioning

There are several other dividend ETFs to be on the lookout for. The 5 ETFs below narrowly missed the cut to be in this article because they did not have the requisite history.
 

Name Symbol AUM Expense Ratio Dividend Yield
Schwab U.S. Dow Jones Div. 100 SCHD $3.2 billion 0.07% 3.0%
S&P 500 Dividend Aristocrats ETF NOBL $1.0 billion 0.35% 2.0%
iShares High Dividend Equity HDV $4.6 billion 0.12% 3.8%
iShares International Select Dividend IDV $2.5 billion 0.50% 5.4%
Wisdom Tree Emerging Markets DEM $1.3 billion 0.63% 5.4%

The Schwab Dividend 100 (SCHD) is notable for its extremely low 0.07% expense ratio. The ETF is designed to minimize investor fees – which is always beneficial.

IDV and DEM both offer investors exposure to international (IDV) and emerging market (DEM) high yield stocks. If currency markets revert, these funds could see solid gains.

The most interesting of the 5 above is the S&P 500 Dividend Aristocrats ETF (NOBL). NOBL replicates the Dividend Aristocrats Index. It has the following characteristics:

This ETF combines equal weighting with high quality dividend paying businesses. I believe it is very likely this ETF generates returns and a Sharpe ratio in excess of the S&P 500 over long periods of time. The historical performance of the Dividend Aristocrats Index is shown below:

Dividend Aristocrats Performance

Regrettably there is not yet an ETF that tracks the Dividend Kings list. The Dividend Kings list is comprised only of businesses with 50+ years of consecutive standards. If the Dividend Aristocrats Index is the ‘gold standard’ in dividend companies, the Dividend Kings list is platinum.

Dividend ETFs Versus Dividend Stocks

Investing in dividend ETFs presents trade-offs. The pros and cons of dividend ETF investing are summarized below:

Pro: Investing in dividend ETFs provides wide diversification. Investors can virtually eliminate firm specific risk by investing in dividend ETFs. This is especially helpful for investors with small portfolios as they can get necessary diversification without wasting money on multiple brokerage commission fees necessary to build a dividend portfolio of individual stocks.

Pro: Investing in dividend ETFs has a very low time commitment. Once purchased, investors can ‘sit and forget’ about their ETF. It will (or should) continue to passively invest in the same strategy; no additional research is required.

Pro: Dividend ETFs tend to have lower annual expense ratios than mutual funds. Several dividend ETFs have annual expense ratios below 0.1%.

Con: While Dividend ETFs tend to have lower expenses than traditional mutual funds, they are still more expensive than owning individual stocks. Individual stocks will always have an expense ratio of 0.0%. You can’t beat that. Low cost brokerages make buying and selling costs minimal. After 1 or 2 years, it is cheaper to own an individual stock than even the cheapest dividend ETF.

Con: You cannot pick what businesses you own with a Dividend ETF. Perhaps the biggest risk individual investors face is selling when prices fall.   Owning an ETF disconnects you from the underlying business you own stock in. For many investors, it is far more comforting to know you own shares in a real world business with a great track record than a large basket of businesses you can’t identify with. The connection to the business helps investors to minimize the risk of selling when prices fall.

Con: Dividend ETFs give you no control over your portfolio. You cannot buy or sell individual stocks. You cannot fine-tune your strategy to match your specific needs. For example, you may only look for businesses with 3%+ yields that have 25+ years of dividend increases that are in stable industries like insurance, health care, and consumer staples. There’s no ETF that replicates that, but you could easily invest in this fashion on your own.

There’s nothing wrong with investing in dividend ETFs. For investors with minimal time and/or interest in investing, dividend ETFs are an excellent alternative to mutual funds and individual stocks.

Dividend ETF Screens & Lists

There are far more dividend ETFs available than could be analyzed in this article. This article examines the more popular dividend ETFs that also have long track records.

Fortunately there are many excellent resources online to quickly find and sort ETFs to find the best dividend ETF for you.

ETF Replay is a website that categorizes ETFs, does historical backtests, and screens ETFs based on various criteria. It is an excellent resource (and many features are free) for investors looking to find the right ETF strategy for them.

ETF DB has an easy to use sortable table of 129 different dividend ETFs. It is a good tool to use to get an overview of the ETF landscape.

Dividend.com also has an easy to use sortable table with a wide variety of dividend ETFs to choose from.

Final Thoughts

The 3 best dividend ETFs most likely to continue outperforming the market based on the data in this article are:

Investors seeking exposure to dividend ETFs should consider these funds before others for their primary dividend exposure.

Thanks for reading this article. Please send any feedback, corrections, or questions to ben@suredividend.com.


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