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Do more stocks make for a better dividend ETF?

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In an echo of real estate’s famed “location” mantra, investment advisors might well say that the three most important success factors are diversification, diversification and diversification.

Diversification among asset classes is crucial, but should you also look for diversification within individual subsets? Specifically, are more dividend payers better than fewer?

We looked at ETFs of domestic dividend payers to find those with the largest number of stocks. Among ETFs with at least $900 million in AUM, only four funds had 400 or more holdings.

By comparison, the segment-leading Vanguard Dividend Appreciation ETF (VIG, 0.08%) holds 182 stocks. We’ve included performance figures for VIG, which returned 16.15% for the year ended August 14, in the accompanying table.

Here are the four most diversified U.S. dividend ETFs:

iShares Core Dividend Growth ETF (DGRO, expense ratio: 0.08%) is based on the Morningstar U.S. Dividend Growth Index. That benchmark starts with domestic stocks that pay qualified dividends, then removes issues with the top 10% of indicated dividend yields. In addition, index components must have at least five years of uninterrupted annual dividend growth, a positive earnings consensus and a payout ratio below 75%. The index is weighted by indicated dividend dollars. DGRO currently has 452 holdings. Financials (18.3%) are the largest sector, followed by health care (17.6%) and information technology (16.2%). Based on current holdings, Morningstar projects DGRO’s yield at 2.40%. For the year ended August 14, DRGO returned 16.37%.

Vanguard High Dividend Yield ETF (VYM, 0.08%) tracks domestic dividend payers from the FTSE All-World Index. REITs are excluded. Stocks are ranked by their indicated dividends and the top half of the selection universe forms the underlying index. VYM holds 405 stocks. Because Vanguard’s policy is to delay reporting holdings, end of July data show financials as the largest sector (16.6%), with health care and consumer goods tied for second at 13.1%. Morningstar expects the forward yield of VYM to be 3.29%. For the year through August 14, the fund returned 11.95%.

WisdomTree U.S. High Dividend Fund (DHS, 0.38%) selects its holdings from the proprietary WisdomTree Dividend Index. Selections must have a minimum market cap of $200 million and are subject to trading volume minimums. Stocks are ranked by dividend yield and the top 30% are included. Stocks are weighted by their proportionate share of the fund’s aggregate dividend. DHS has 443 stocks with the leading sector positions held by real estate (14%) and a tie between health care and consumer staples at 13.1% each. Morningstar sees the forward yield of the fund at 4.06%. Through August 14, the one-year return was 7.67%.

WisdomTree U.S. SmallCap Dividend Fund (DES, 0.38%) is based on a proprietary WisdomTree index. Selection starts by removing the 300 largest U.S. dividend payers. The small-cap index, which currently holds 721 stocks, consists of the bottom 25% of the remaining companies by market capitalization. A stock’s weight in the index is determined by its expected dividend as a portion of the entire fund’s aggregate cash dividend. Sector and stock caps are in effect. Consumer discretionary stocks make up 21.7% of the fund’s holdings, industrials account for 17.9% and real estate another 13.8%. Morningstar projects the yield of DES at 3.97%. For the 12 months through August 14, the ETF returned 17.73%.

Do more stocks mean better performance? The results are inconclusive.

DES, which holds the largest number of stocks, did well over the past one- and three-year periods, but underperformed longer term. DHS underperformed VYM, yet both are high yield funds and have a similar number of stocks. DGRO has a shorter record, but has done well.

It may be best to pick dividend ETFs that match your methodology and expense preferences without regard to the number of stocks they hold.

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