ETF Central's Ultimate Guide to Dividend Investing, Part 5: Hybrid Dividend ETFs

What are hybrid dividend ETFs?

This taxonomy is relatively new territory, so this is my best attempt at distilling the vast universe of these ETFs into a general, standardized, and applicable classification system.

To me, a hybrid dividend ETF is an index or rules-based fund that explicitly targets two or more fundamental metrics that underpin dividend investing or combines a dividend strategy with a factor or smart-beta one.

For the former, you may see ETFs that combine dividend growth with dividend quality, ensuring that the companies in the portfolio not only have a track record of increasing dividends but also possess the financial stability to continue doing so.

For the latter, you may see ETFs that combine high dividend yields with low volatility, aiming to provide investors with a steady income stream while minimizing the ups and downs typically associated with the stock market.

Why buy hybrid dividend ETFs?

Hybrid dividend ETFs are attractive because they combine multiple dividend strategies and screeners to address the weaknesses inherent in each individual approach.

For example, high-yield dividend ETFs provide excellent income and may offer low valuations, but they can also include companies with shaky fundamentals—often referred to as yield traps. These are companies that offer high yields but are at risk of cutting their dividends due to poor financial health.

On the other hand, dividend quality ETFs may not offer the highest yields but ensure the reliability of the dividend by screening for earnings stability and sustainable payout ratios.

However, a company may have a rock-solid and reliable dividend that hasn't grown over time, and thus, has been eroded by inflation. A dividend growth screen could address this by selecting companies that not only pay dividends but also increase them consistently.

Dividend yield, dividend quality, and dividend growth—while implementing all three can be challenging due to their often-conflicting criteria and the resulting limited pool of available companies—you can still pair two together based on your investment objectives.

Moreover, you still have the option to apply smart-beta or factor screens to further refine your investment. For example, pairing dividend strategies with factors like momentum or low volatility can help tailor the ETF to specific risk profiles or market conditions.

Some real-life hybrid dividend ETF examples

One of the hybrid dividend ETFs on my personal watchlist is the WisdomTree U.S. Quality Dividend Growth ETF

This ETF has consistently beaten the S&P 500 historically and has a five-star Morningstar rating, meaning it has outperformed the majority of its peer category on a risk-adjusted basis.

While it doesn't offer a high yield, it effectively targets both dividend growth and quality screens. Specifically, it screens for long-term earnings growth expectations and three-year historical averages for return on equity (ROE) and return on assets (ROA).

Additionally, it is fundamentally weighted based on the proportionate share of the aggregate cash dividends each component company is projected to pay in the coming year.

Another notable example that combines a dividend metric with a smart beta/factor approach is the Franklin U.S. Low Volatility High Dividend Index ETF

This ETF starts by screening 3,000 stocks from the Solactive U.S. Broad Market Index for a history of paying a high dividend yield relative to the universe.

Each selected company must have been profitable over its last four fiscal quarters and is projected to remain profitable over the next four quarters based on consensus analysts' earnings forecasts.

LVHD then calculates a "Stable Yield" score for each security based on the company's dividend yield, adjusted for stocks with lower or higher price and earnings volatility.

Price volatility is measured over the prior 12 months using daily returns, and earnings volatility is based on the prior three years of earnings and the upcoming two years of analysts' projected earnings.

These are just two notable, historically well-performing hybrid dividend ETFs. But if you shop around, you may be able to find ones with different combinations of screeners.

Stay tuned for the finale of this series, where we will look at enhanced dividend ETFs that use financial engineering or derivatives to boost returns.

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.