ETF Central's Ultimate Guide to Dividend Investing, Part 2: High-Yield Dividend ETFs

High yield dividend ETFs can provide income

Prior to 2022, when interest rates began to rise steadily and aggressively to the 5.25 - 5.5% range we see today, investors had to look outside of Treasury bills for income. When interest rates were much lower, high-yield dividend strategies were particularly attractive, with some paying above 4%.

These ETFs commonly work by tracking a dividend-focused benchmark index. For example, the SPDR Portfolio S&P 500 High Dividend ETF

selects the top 80 high dividend-yielding companies within the S&P 500 Index and equal weights them. By doing so, it achieves a 4.65% 30-day SEC yield as of June 18 and pays monthly distributions—a highly desirable feature for income investors.

However, you'll find significant variations between ETFs. One common distinction is based on the hurdle rate set to qualify a potential holding as "high yield" or not. For example, SPYD picks the top 80 highest-yielding stocks in the S&P 500, but the Vanguard High Dividend Yield ETF

excludes companies that yield below the 55th percentile in its selection universe.

Weighting strategies can also differ. SPYD weights its 80 stocks equally, but a fundamentally weighted dividend ETF like the WisdomTree U.S. High Dividend Fund

weights stocks based on the dollar value of their dividend payouts. This means that stocks contributing more to the fund's dividend income have a higher weight in the portfolio.

Sector differences are another important aspect to consider. Typically, high-yield dividend ETFs will have a higher weighting towards industries like financials, consumer staples, utilities, and energy, whereas sectors like technology and consumer discretionary may be underweighted. Additionally, depending on the index, real estate investment trusts (REITs) may be excluded altogether.

Regardless of these differences, the key takeaway is that virtually all ETFs in the high-yield category will pay income greater than a broad market index benchmark of the same geography. This makes them a valuable tool for investors seeking higher income from their investments.

High-yield dividend ETFs can target value stocks

Another unintended, albeit effective, use for high-yield dividend ETFs is as a low-cost proxy or substitute for value factor ETFs.

In the context of investment strategies, the value factor—defined by the Fama-French three-factor model—systematically identifies stocks that trade for less than their intrinsic values based on price-to-book ratios.

To understand why high dividend yields can serve as a preliminary value screen, it's essential to grasp how yield is calculated – by dividing a company's annual dividend by its share price.

Therefore, a high dividend yield can indicate a lower share price relative to the dividend paid, which can reliably point to a stock being undervalued or out of favor, all else being equal.

This is a reason why the "Dogs of the Dow" strategy, which involves picking the top 10 highest-yielding blue-chip Dow stocks each year, has performed decently over time.

For example, as seen below, a factor regression of VYM and the Vanguard Value ETF

show statistically significant loadings to value (High Minus Low, or HML), despite the former not explicitly targeting value stocks.

In a 2017 whitepaper, Vanguard confirmed this relationship, noting: "The performance of these [dividend] strategies has been time-period dependent and largely explained by their exposure to a handful of equity factors: value and lower volatility for high-dividend-yielding equities and lower volatility and quality for dividend growth equities."

This concludes our article on high-yield dividend ETFs and segues neatly into our next, upcoming article on dividend growth ETFs.

 

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.