How The Fed Can Affect These Dividend ETFs

All eyes are on the Federal Reserve this week with many fixed income traders indicating the first rate hike of 2017 is all but a done deal. Higher interest rates could affect a wide array of income-generating asset classes and sectors, including some dividend exchange traded funds.

Some dividend ETFs feature heavy allocations to higher-yielding sectors, such as consumer staples and utilities. Given the bond-like qualities of those groups, particularly utilities, ETFs with large weights to those sectors can be vulnerable to higher interest rates.

“Since 1953, whenever the yield on the S&P 500 index was within one percentage point of the yield on the 10-year Treasury, as it currently is, the S&P 500 rose in price an average of 11% in the following 12 months, and had positive results 77% of the time, according to Sam Stovall, chief investment strategist at CFRA,” said CFRA Research in a note out Monday.

Home to $17.1 billion in assets under management, the iShares Select Dividend ETF DVY is one of the largest U.S. dividend ETFs. DVY's trailing 12-month yield of 2.92 percent isn't alarmingly high, but the ETF's 28.5 percent weight to utilities stocks, by far its largest sector allocation, could be a cause for concern.

DVY “has shed $302 million in assets to start 2017. DVY focuses on companies with a five-year record of paying dividends and a relatively high yield. Relative to the S&P 500 index, the ETF is significantly overweighted to defensive utilities (28 percent vs. 3 percent),” said CFRA.

The Vanguard High Yield Dividend ETF VYM clearly advertises itself as a high dividend ETF, but a trailing 12-month yield of 2.8 percent might indicate otherwise. Additionally, for a high yield strategy, VYM's utilities weight is relatively low at just 7.8 percent.

VYM “experienced $393 million of net outflows year to date. VYM has a comparable 2.8 percent yield, but the sector exposure is distinct from DVY’s. The overweighting to utilities (8 percent) is more muted, but exposure to AT&T T and other telecom services (5 percent) is higher,” said CFRA.

CFRA has a Market Weight rating on DVY and an Overweight rating on VYM. Over the past three years, DVY is up 40.6 percent, while VYM is higher by 38.9 percent.