The first dividend-themed ETF arrived on the scene just over a decade ago, when the iShares Select Dividend ETF (DVY) launched in November 2003. Within three years there were seven ETFs focused on domestic dividend stocks.

One of the seven folded its tent in 2009; the other six are still available. Now that they all have five-year performance data available, advisors can compare the group over that period. (See table below.)

Only two dividend ETFs outpaced the 15.70% annual total return of the S&P 500 index for the five years ended Sept. 30. The iShares Dow Jones Select Dividend ETF had the best total return at 16.39% annually for the period, while in second place was the First Trust Morningstar Dividend Leaders Index Fund (FDL), with a 16.33% annual return.

Not one of the six dividend ETFs beat the S&P 500 over the one year ended Sept. 30. That’s not surprising: Dividend strategies tend to underperform in strong markets, and despite recent market weakness, equities have done well over the past year.

WHERE THE FUNDS DIFFER

The six funds all require minimum market capitalizations and have sector or industry caps, and each of these six ETFs parses the dividend world in a different way.

  • The iShares Select Dividend ETF is based on the Dow Jones U.S. Select Dividend Index. That index requires constituent companies to have a five-year non-negative dividend-per-share growth rate, dividends paid in each of the past five years, earnings that are at least 67% higher than dividends on average for the past five years, and non-negative trailing 12-month earnings per share. The index (and resulting ETF) includes the top 100 qualifying companies as measured by dividend yield. 
  • The First Trust Morningstar Dividend Leaders Index Fund tracks its namesake Morningstar index. That index takes all U.S. dividend-paying stocks (except REITs) and applies the following screens: The current dividend must be equal to or greater than the dividend five years ago, and the indicated dividend must be lower than the forward earnings estimate. Again, the index includes the top 100 stocks by yield.
  • The SPDR S&P Dividend ETF (SDY) follows the S&P High Yield Dividend Aristocrats Index, which requires 20 consecutive years of shareholder payment increases. The index is weighted by annual dividend yield; stocks are drawn from the S&P Composite 1500 Index.
  • The PowerShares High Yield Equity Dividend Achievers Portfolio (PEY) is based on the Nasdaq U.S. Dividend Achievers 50 Index, which includes the 50 highest-yielding stocks with at least 10 consecutive years of increasing annual dividends. REITs and limited partnerships are excluded, and no sector may contribute more than 12 stocks.
  • The PowerShares Dividend Achievers Portfolio (PFM) tracks the Nasdaq U.S. Broad Dividend Achievers Index, which includes U.S. companies that have increased their dividends for at least 10 consecutive years. This version of the Nasdaq index also includes REITs and Limited Partnerships. 
  • The Vanguard Dividend Appreciation ETF (VIG) is based on the Nasdaq U.S. Dividend Achievers Select Index. That index requires 10 consecutive years of dividend increases and excludes limited partnerships and REITs. The ETF also applies proprietary screening criteria that are not disclosed by Nasdaq or Vanguard.

Why have DVY and FDL outperformed the others over the past five years? It may actually be because they require only a five-year dividend record, rather than the 10 or 20 years of increases mandated by their competitors.
Many companies start paying dividends at a low rate and boost them significantly in the first few years. That often causes share prices to rise, improving the total return. These funds also require earnings to be greater than dividends.

The takeaway for advisors: Know how an underlying index works before buying a dividend ETF.

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