This Dividend ETF May Not Be As Expensive As It Looks

In a year in which investors are displaying an overt affinity for low volatility stocks and exchange traded funds and during a period in which rate-sensitive sectors are obviously benefiting from the Federal Reserve's “lower for longer” policy on interest rates, it's easy to understand why some critics allege that dividend stocks are overvalued.

The PowerShares S&P High Dividend Low Volatility Portfolio SPHD would appear to be an obvious candidate for “overvalued dividend ETF” recognition. After all, SPHD is one of this year's hottest dividend ETFs thanks to be a low volatility fund that is chock full of high-yield dividend stocks. SPHD has a trailing 12-month distribution rate of 3.6 percent and allocates a combined 32.2 percent of its weight to rate-sensitive utilities and real estate stocks, making it an easy target for those eager to criticize low volatility and dividend ETFs.

Perhaps SPHD isn't as richly valued as some might guess. Better yet, SPHD's low volatility feature can help investors some potentially vulnerable dividend payers.

“Combining a high dividend approach with the low volatility factor may help avoid overvalued stocks, without sacrificing income potential. This strategy first targets stocks with high dividend yields. Then, as stocks become more expensive and their dividend yields decrease, a rebalancing mechanism removes them in favor of undervalued stocks with more attractive dividends. Additionally, the low volatility screen allows the strategy to remove potential dividend traps – situations in which a high dividend can mask a declining stock price or faltering company,” said PowerShares in a recent note. 

With its emphasis on low volatility and high yields, SPHD can be considered a multi-factor strategy. The ETF holds the 50 S&P 500 stocks with the lowest trailing 12-month volatility and highest dividend yields, hence the significant allocations to real estate and utilities stocks.

SPHD's status as a low volatility dividend fund might imply that it is an exclusively large-cap ETF, but the fund has decent exposure to mid-caps, another market segment where low volatility strategies are winning this year. The ETF allocates over 43 percent of its combined weight to mid-cap value and blend stocks.

“It is not only the broad market that has experienced high valuations; some dividend stock strategies are also seeing high valuations, as evidenced by the chart above. This is due to the inverse relationship between yields and security prices, as well as to the popularity of dividend strategies as a whole. In fact, more than $100 billion in assets have flowed into dividend-oriented exchange-traded funds (ETFs) over the trailing five years through Aug. 31, 2016,” adds PowerShares.

For its part, SPHD, which turns four later this month, is now home to more than $2.7 billion in assets.

Disclosure: The author owns shares of SPHD.