A Nifty Dividend Growth ETF

Market volatility has been a boon for defensive sectors this year, namely consumer staples and utilities. Seasoned income investors know that while the consumer staples and utilities sectors have some dividend perks, these groups often trade at rich multiples relative to the broader market.

Additionally, the Federal Reserve passed on raising interest rates earlier this month, but there is speculation the Fed could reverse course at its April meeting. Plus, if U.S. economic data improves, the data-dependent Fed would have room to further boost borrowing costs, pressuring rate-sensitive dividend destinations in the process.

A potentially challenging interest rate environment from a Fed that lobs off next to nothing in the way of actionable clues coupled with the frothy valuations on some defensive sectors should prompt investors to examine newer sources of dividend growth and exchange-traded funds such as the iShares Core Dividend Growth ETF (iShares Trust DGRO).

Dividend Growth In DGRO

“After years of investors chasing the highest yielding stocks, many classic defensive sectors—utilities and telecom, for example—have gotten expensive. In contrast, dividend growth stocks, primarily from cyclical sectors like technology, tend to be higher quality and less expensive than those higher yielders. These high quality companies tend to have stronger balance sheets, lower levels of debt, better earnings growth and higher free cash flow which allows them to grow their dividends year after year,” according to a recent BlackRock note.

Related Link: A Dependable Dividend ETF

The $431 million DGRO, which turns two in June, does feature consumer staples as its largest sector weight at 15.6 percent. However, the ETF is highly allocated to sectors that are chock full of stocks that can be considered quality and/or value plays. For example, financial services (value) and technology (quality) names combine for nearly 28 percent of DGRO's weight.

DGRO follows the Morningstar US Dividend Growth Index, which requires constituent firms have a minimum of five years of uninterrupted dividend growth. The index also purposefully avoids stocks with high and potentially unsustainable dividend yields by excluding firms with yields that rank in the top 10 percent of the eligible inclusion universe and only companies with a payout ratio of less than 75 percent can be included, according to Morningstar.

“Admittedly, during the aggressive quantitative easing measures by the Fed over the past few years, high yielding dividend stocks have done quite well. Now, as many investors worry about a global growth slowdown, rising rates and higher volatility in U.S. equity markets, dividend growers offer potential opportunities due to their healthy balance sheets, as well as better valuations, and lower volatility,” added BlackRock.

As interest rate normalize, dividend investors should turn to lower yielding sectors with room for dividend increases in the coming years while skirting groups that have been home to negative dividend action or are vulnerable to higher rates. On that note, dividend offenders energy and materials names combine for just over 10 percent of DGRO's weight while utilities chime in at 5.2 percent. Those are the ETF's three smallest sector allocations.