H istorically low interest rates have polished the appeal of dividend equity ETFs. But with interest rates widely expected to rise by year-end, what can investors expect? Dividend-paying firms could be hard hit when the Federal Reserve normalizes policy. With stable cash flows, they typically don't get the same boost that nondividend payers do from an improving economy .
But in a rising rate environment, dividend growth ETFs should fare better than dividend yield strategies, panelists on a Charles Schwab media call on dividend equity investing noted Friday.
"Historically, there is not that cyclicality as in high yield," said Simeon Hyman, ProShares' head of investment strategy. "They don't have that bond sensitivity associated with them." But dividend equity investing has a hidden bias, the panelists said. Most dividend ETFs focus on large caps. There are almost twice as many dividend-paying stocks in large caps as in small.
Many investors associate small caps with growth and potentially higher returns, not dividends, Hyman said. With a dividend ETF strategy , investors can have both.
ProShares says that its four dividend growth ETFs "curate" firms from well-known indexes with the longest track records of growing dividends. One ETF, launched in February, focuses on small caps.
ProShares Russell 2000 Dividend Growers ( SMDV ) invests in 55 names that raised dividends in each of the past 10 years. Holdings include payments processorCass Information Systems ( CASS ),West Pharmaceutical Services ( WST ) and grains distributorAndersons ( ANDE ). These small caps are firms of higher quality, based on balance sheets, earnings and debt levels, than peers offering the highest dividend yield. SMDV has $5 million in assets and a 0.4% expense ratio.
The $1.28 billionWisdomTree SmallCap Dividend ( DES ), meanwhile, weights holdings by dividends, focusing on quality rather than high yield alone. DES is up 0.9% in 2015. It's more diversified and less costly than SMDV. It yields 2.9%.
Small caps can be risky. The potential for higher gains can come at the cost of violent price swings.
But small-cap dividend growers are less volatile than stocks that don't pay dividends or that pay but don't grow dividends, Ned Davis Research data shows. They have lower drawdowns; that is, they don't lose as much when the market declines. "You can have your cake and eat it too," Hyman said. " Investors can participate in small-cap growth with higher quality names and less volatility."
On Schwab's ETF platform, dividend ETFs holding large- and midcap stocks saw net outflow in the first half of 2015.
"This offset the positive flow we saw going into small-cap dividend ETFs," said Heather Fischer, a Schwab vice president.
Small caps outperformed recently and could shine when rates rise. They adapt more nimbly when economic currents shift.