Don't Fret About This High Dividend ETF

High dividend stocks and exchange-traded funds are often thought to be vulnerable when the Federal Reserve embarks upon rate tightening cycles. For instance the WisdomTree U.S. High Dividend Fund DHS tracks an index that has a trailing 12-month dividend yield of 4.08 percent and since the start of 2018, the S&P 500 has outpaced DHS by a significant margin.

DHS allocates more than 13 percent of its weight to real estate stocks, its second-largest sector allocation. The fund also devotes 18.52 percent of its combined weight to the rate-sensitive utilities and telecommunications sectors. All of that is to say that the ETF's laggard status in the face of four Fed rate hikes since the start of last year isn't surprising, but over the long term, DHS has the potential to surprise even as borrowing costs climb.

Declining Treasury yields don't guarantee outperformance by high dividend strategies. Those declining rates merely make, in theory, high-yield strategies more attractive.

What To Know

“From April 19, 2013, to July 8, 2016—when rates were falling by 35 basis points (bps) to that generational low—the S&P 500 Growth Index posted a total return of 53.56 percent while the WisdomTree U.S. High Dividend Index rose 'just' 45.12 percent, a gap of 844 bps (199 bps annualized),” said WisdomTree in a recent note.

Year-to-date, DHS has been hampered by its exposure to sectors deemed as rate-sensitive as well as lack of exposure to groups that benefit from higher interest rates. For example, the fund devotes just 6.71 percent to financial services stocks, but that time is probably too narrow in which to measure DHS's rising rates abilities.

Why It's Important

If it were a trade, expectations for higher interest rates this year would likely be seen as crowded.

“And crowded is an understatement: 38 of 43 economics teams anticipate a rise in 10-Year Treasury yields by the fourth quarter of 2019, with a median target of 3.42 percent,” said WisdomTree. “If they are proven wrong—and if the market keeps 'caring' about rates in 2018 the way it did in 2016 and 2017—DHS could surprise investors to the upside.”

What's Next

The case for DHS isn't done. In fact, the ETF has some rebound potential. Its largest sector weight is the rebounding energy patch at 13.28 percent. That sector often performs well when rates and inflation rise. Additionally, DHS allocates almost 23 percent of its combined weight to health care and technology names -- sectors that have been durable in previous tightening environments.

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