An ETF For Solving High Dividend Yield Issues

Many income investors are seduced by high dividend yields and it is easy to understand why. Yields on 10-year Treasurys are around 1.8 percent. The S&P 500 yields less than 2.2 percent on a trailing 12-month basis, so it is not surprising that investors gush for stocks and dividend exchange traded funds sporting yields in the three percent, four percent and higher areas.

However, high dividend stocks can teach some hard lessons. Obviously, dividend yields become high because a stock's price declines and that is not a positive. Additionally, high dividend yields can be a sign of an unsustainable dividend and while big yields are nice, dividend sustainability and growth are more important. Of course, plenty of income investors also know that high dividend stocks can prove vulnerable to hawkish changes in interest rates.

Another issue with high-yield dividend stocks is volatility with these issues is often higher than it is with their lower yield counterparts. The PowerShares S&P 500 High Dividend Low Volatility Portfolio SPHD is an example of an ETF that can ameliorate that problem.

“Fortunately, we believe there is one way to reduce the possibility of 'dividend traps' without sacrificing yield potential – the addition of a low volatility screen. By using a low volatility screen, investors may be able to generate high current income while avoiding “dividend traps” that can sink an investor’s portfolio,” said PowerShares in a recent note.

For the three-year period ending Feb. 29, 2016, the combination of high dividends and low volatility generated robust income while reducing volatility relative to other dividend strategies and the S&P 500, according to PowerShares data.

SPHD has a 12-month distribution rate of nearly 3.3 percent and the ETF is 12.1 percent year-to-date. The ETF finished last Friday just pennies below an all-time high. The $1.1 billion SPHD allocates about 40 percent of its combined weight to financial services and utilities stocks, but with most of the ETF's financial holdings benefiting from lower interest rates, SPHD has been one of the best-performing dividend ETFs this year. 

“SPHD is a multi-factor strategy whose underlying index screens for high-yielding securities while also making use of a low volatility screen. SPHD provides access to 50 S&P 500 Index holdings that historically have provided high dividend yields with lower volatility. The result is an exchange-traded fund with high yield potential and reduced risk of high volatility and 'dividend traps,” said PowerShares.

Investors are responding as highlighted by the fact that SPHD has added $494.5 million of its $1.1 billion in assets just this year.

Todd Shriber owns shares of SPHD.