ETFs for dividend-thirsty clients — albeit with greater risk

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Dividend-seeking clients may have thought the yield drought was ending when the Fed began raising short-term rates. But with those increases now on hold, the oasis is looking more like a mirage. The 10-year Treasury is yielding just 2.50% — down from 3.24% in early November.

One workaround to this dilemma might be ETFs that hold dividend-paying stocks. These products can supplement income, albeit at greater risk as reaching for higher yields increases that risk potential. But some ETFs with higher yields also have higher Sharpe ratios, indicating better risk-adjusted performance.

Here are three dividend ETFs with decent Sharpe ratios. All have forward yields at least 100 basis points higher than the 10-year T-note as calculated by Morningstar.

FlexShares Quality Dividend Defensive Index Fund (QDEF, expense ratio: 0.37%) holds 158 dividend-paying stocks that have been screened for several factors that indicate quality. Sector and stock caps are used to ensure diversification. The portfolio is structured to have a beta lower than the market. The fund, which was launched in December 2012, has its largest concentrations in information technology (22.55%), financials (12.28%) and health care (10.93%). Through April 9, QDEF’s year-to-date, three-year and five-year returns are 14.79%, 12.64% and 10.50%, respectively. Through March 31, the ETF’s three- and five-year Sharpe ratios are 1.06 and 0.94, respectively. Morningstar sees QDEF’s forward dividend yield at 3.53%.

Invesco High Yield Equity Dividend Achievers (PEY, 0.54%) was featured last month as the dividend ETF with the best 10-year performance during the bull market. It also has one of the highest forward yields at 4.73% and has displayed Sharpe ratios above 1.00 in two of the three periods considered. The portfolio holds only 50 stocks, the highest yielding among equities with at least 10 consecutive years of dividend increases. PEY’s biggest sector bets are in utilities (24.66%), consumer staples (23.18%0) and financials (19.76%). Through April 9, PEY’s YTD, three-year, five-year, and 10-year total returns are 14.18%, 12.55%, 11.95% and 15.83%, respectively. The fund’s Sharpe ratios for the three-, five-, and 10-year periods ended March 31 are 0.95, 1.01 and 1.31, respectively.

Tax-efficient funds with best 10-year returns
The average expense ratio among the top-performers is 40 basis points higher than the average.

Schwab U.S. Dividend Equity (SCHD, 0.06%) is based on an index of 100 stocks chosen from the 2,500 largest U.S. equities. Candidates must have 10 consecutive years of dividend increases and are ranked on several fundamental factors. Largest sector concentrations are in consumer staples (22.87%), industrials (17.80%) and technology (16.84%). Through April 9, SCHD has posted total returns of 13.56%, 12.99% and 10.58% for the YTD, three- and five-year periods, respectively. Through March 31, the ETF has Sharpe ratios of 1.06 and 0.91 for the three- and five-year periods, respectively. Launched in October 2011, SCHD has a forward yield of 3.55%, according to Morningstar.

Worth mentioning is an ETF that didn’t make the cut because of a lower forward yield: First Trust Value Line Dividend Index Fund (FVD, 0.70%), which has a projected yield of 3.22%. Although it’s below our cutoff of 3.50% FVD was the only dividend ETF we encountered that had Sharpe ratios above 1.00 for the three-, five- and 10-year periods we considered.

Some advisors may wonder why we did not screen on SEC yield or 12-month trailing yield. Both these measures look back at the income that a portfolio earned, not at what it is expected to earn in the coming year. The forward yield is an estimate based on the holdings of the fund and the indicated dividend (the most recent quarterly announcement multiplied by four) of each stock in the portfolio.

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