Dividend ETF's Stiff Requirements Prove Fruitful For Investors

Some dividend exchange traded funds have requirements regarding the stocks that qualify for admission into the portfolio. Others, well, they take the requirement gambit up a notch and, in some cases, investors benefit.

The SPDR S&P Dividend ETF SDY is in the latter camp. SDY, one of the largest dividend ETFs by assets, follows the S&P High Yield Dividend Aristocrats Index. That benchmark mandates that member firms have dividend increase of at least 20 years. Just two other ETFs, one of which is a new fund, have longer payout hike requirements.

This year, SDY's strategy is working. The fund is up 21.6%, including dividends paid, and has been 110 basis points less volatile than the S&P 500.

Why It's Important

SDY charges 0.35% per year, or $35 on a $10,000 investment, and while there are cheaper dividend funds on the market, SDY stacks up favorably in terms of performance against actively managed peers and some passive value strategies.

“State Street Global Advisors charges a fee of 0.35% for this fund. This cost advantage relative to actively managed peers has translated into strong category-relative performance over the long term,” Morningstar said in a recent note. “Over the trailing 10 years through August 2019, the fund has outperformed the Russell 1000 Value Index by 152 basis points annualized with slightly lower risk. Overall, this fund should continue to enjoy a durable long-term edge over many of its competitors thanks to its cost advantage compared with its peer average and lower-than-average cash drag.”

While SDY is fashioned as a high dividend play, it yields just 2.38%, indicating it has ample room for payout growth while steering clear of high-yield stocks that could be dividend cutters.

“Reaching for yield may be tempting in a historically low interest-rate environment. However, aggressively chasing yield can court risk, as high-yielding stocks may have weak fundamentals and be prone to cutting their dividend payments,” according to Morningstar. “These companies may pay out a large share of their earnings and have a narrow buffer to cushion these payments if their business deteriorates compared with their lower-yielding counterparts.”

What's Next

None of SDY's 112 holdings exceed weights of 2.38% and the fund isn't excessively allocated to traditional high dividend destinations, such as real estate and utilities. Rather, SDY allocates over a third of its combined weight to industrial and financial services stocks, two steady dividend growth sectors.

Morningstar has a Silver rating on the State Street ETF.

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