Quality Conundrum For Dividend ETFs

The quality factor is a favorite among advisors and investors, but it has been a disappointment this year, lagging its momentum rival. Quality's laggard status has also plagued some dividend exchange-traded funds, a scenario that has put some income investors in a bind.

Adding to the conundrum is the fact that many of the dividend ETFs rooted in quality also hold ample amounts of high-yielding stocks in interest rate-sensitive sectors. High-yield dividend ETFs, particularly those with a direct or incidental emphasis on the quality factor, have proven vulnerable to speculation that the Federal Reserve is set to finally raise interest rates. This is due to the trend that those funds usually feature large allocations to rate-sensitive sectors such as consumer staples, real estate and utilities.

Related Link: Fed Preparation With Currency Hedged ETFs

Strategizing

One strategy income investors can implement with dividend ETFs is to eschew yield in favor of those funds that emphasize dividend growth. The Schwab Strategic Trust SCHD, home to nearly $2.7 billion in assets under management, gives investors cost-effective exposure to dependable dividend growth.

“In terms of the underlying portfolio, the index that this fund tracks looks to screen for companies that have paid dividends for 10 years straight, at a minimum, and ideally are growing those dividends with time,” said Morningstar Global ETF Research Director Ben Johnson.

SCHD, which tracks the Dow Jones Dividend 100 Index, is also one of the least expensive U.S. dividend ETFs with an annual expense ratio of just 0.07 percent, or $7 per $10,000 invested. Plus, Schwab clients can trade the ETF commission-free on the Schwab ETF OneSource platform.

The Fund

Although SCHD's 108 holdings have dividend increase streaks of at least 10 years, the ETF features a good mix of old dividend growth combined with exposure to sectors that are leaders of next generation dividend growth.

For example, SCHD allocates a combined 42.6 percent of its weight to consumer staples and technology stocks, according to Schwab data.

Conversely, SCHD's weight to the financial services sector is less than 2 percent because many companies from that group pared dividends during the financial crisis. Additionally, SCHD mitigates vulnerability to higher interest rates with a combined of less than 4.9 percent to rate-sensitive telecom and utilities stocks. SCHD also features an extensive lineup of wide moat companies.

“So if you look at the percentage of the portfolio's assets that are in either wide- or narrow-moat firms it's nearly 100 percent. So these are very high-quality firms, with sustainable competitive advantages that allow them to preserve and ideally grow over time, those cash flows that they are sharing with investors in the form of dividends,” added Morningstar.

SCHD's trailing 12-month distribution yield is 2.94 percent and the weighted average market capitalization of the ETF's constituents is just over $91 billion, according to issuer data.