In our last installment of Under the Hood, you’ll recall I compared and contrasted the two US dividend products that iShares offers (DVY and HDV). Since the topic of yield isn’t going away any time soon, it only seems natural to expand the conversation to our largest dividend ETF competitors – the SPDR S&P Dividend ETF (SDY) and the Vanguard Dividend Appreciation ETF (VIG).
I know I sound like a broken record, but I can’t stress enough that all ETFs are not alike – even though their names sometimes make it sound like they are. When investors are comparing these products, they should look at factors like exposure, provider, structure, liquidity and costs. Our website has a nice explanation of these criteria here, and to find this information about each of the funds, you can click on their links above.
When it comes to dividend ETFs, I’ve found that the biggest variation between products is the exposure you’re getting. Overlap between these four dividend ETFs ranges from 9-33%. How can four ETFs with the word “dividend” in the name have so few holdings in common? The answer lies in the different indexes these funds seek to track.
For example, while all of these indexes require some history of paying dividends, they differ in terms of length of track record and dividend growth requirements. The Dow Jones U.S. Select Dividend Index (DVY’s benchmark) requires that a company’s dividend be higher than its 5 year average, while the Mergent Dividend Achievers Select Index (VIG) and the S&P High Yield Dividend Aristocrats Index (SDY) require 10 and 25 consecutive years of dividend growth, respectively. And the Morningstar Dividend Yield Focus Index (HDV) only requires that dividends have been paid the past 5 years, but doesn’t have any specific dividend growth mandate (Morningstar chooses to focus on quality screens vs. dividend growth track record – more on that in a later blog post).
So how does this affect exposure? You can see the difference illustrated in the fact that the Dow Jones Index includes entities that have spun off as “new” companies in the past 5-10 years – names like Phillip Morris (NYSE: PM). The Mergent and S&P indexes don’t include PM because it doesn’t have the required track record as of yet.
The dividend growth requirement can also affect index holdings. For example, Merck (NYSE: MRK) paid out a dividend of $1.52 every year from 2005-2010 before increasing it to $1.56 in 2011. Keep in mind that during this timeframe, the fallout of 2008-2009 caused many firms to decrease or cut dividends at the start of the recession. But because Merck’s dividend did not grow over those five years, it was not eligible for the Mergent and S&P indexes – and won’t be eligible for 9 and 24 more years, respectively (provided the dividend continues to grow year over year). Today, Merck is currently yielding over 4%, and is in the top 10 constituents for Morningstar and the top 20 for Dow Jones. Why? Because those indexes don’t require consecutive years of dividend growth.
Now, the fact that the differing index methodologies cause different exposures is not a good or bad thing; it’s simply a data point that investors can use when choosing between the products. If it were me, I would ask myself how much emphasis I think should be placed on length of track record and demonstrated growth in order to capture the right mix of dividend paying companies. Whatever the answer, the variety of dividend ETFs available today ensures that there’s an investment tool available to suit most people’s needs.