Low volatility, high dividend sectors such as utilities health care and consumer staples have driven stocks higher. With a potentially bumpy ride ahead for investors over the next few months, dividends may take on increased appeal.
"While we believe equities should move higher in the next twelve months, the journey will likely be a volatile one. With that in mind, we think investors might find investment strategies focused on consistent dividend-paying stocks appealing. Not only can they help protect against downside in a market pullback, they can also aid returns during a subsequent potential market rally," said S&P Capital IQ in a new research note.
The research firm pointed out that since 1926, more than 40 percent of the total return for the S&P 500 has come from reinvested dividends.
Investors have plenty of dividend ETFs from which to choose, but the largest by assets is the Vanguard Dividend Appreciation ETF (NYSE: VIG ). The Vanguard Dividend Appreciation ETF, which is home to nearly $14.6 billion in assets under management, garnered an Overweight rating from S&P Capital IQ.
VIG has annual expense ratio of 0.13 percent, making it less expensive than 88 percent of comparable funds, according to Vanguard . The ETF tracks the NASDAQ US Dividend Achievers Select Index, which requires constituents to have increased dividends every year for at least the past decade.
"While the stocks inside this portfolio have strong records of dividend increases, investors should be mindful that dividend increases due not occur in perpetuity," said S&P in the note. "So we think looking at the underlying holdings' earnings potential to see if there is room for dividend growth is warranted. We believe that a dividend-to-earnings payout percentage of below 70% gives a company flexibility to invest for growth and still raise its dividend. As of the end of 2012, the S&P 500's payout ratio was 43%, versus an average of 52% since the mid-1930s."
VIG holds 147 stocks and its top-10 holdings represented 39.5 percent of the ETF's weight as of March 31. The ETF yields around 2.2 percent and is surprisingly light on some of investors' favorite dividend sectors. Telecommunications and utilities combine for just 1.3 percent of VIG's weight while health care receives an allocation of 8.4 percent.
VIG makes up for that with a 24 percent weight to consumer staples names. In fact, four of VIG's top-five holdings - PepsiCo (NYSE: PEP ), Procter & Gamble (NYSE: PG ), Coca-Cola (NYSE: KO ) and Wal-Mart (NYSE: WMT ) - are also four of the top six holdings in the Consumer Staples Select Sector SPDR (NYSE: XLP ).
Other prominent sector weights in VIG include 18.7 percent to indusrials, 12.8 percent to consumer discretionary and 12.4 percent to energy. Eight of the ETF's 10 largest holdings are members of the Dow Jones Industrial Average with Pepsi and Abbott Labs (NYSE: ABT ) being the outliers.
Through March VIG and its mutual fund equivalent, the Vanguard Dividend Appreciation Index Fund ( VDAIX ) had a "beta of 0.84 and the standard deviation of 12.8 for both funds were relatively low compared to the S&P 500 Index and the broader equity ETF and mutual fund universes that S&P Capital IQ has rankings on," according to S&P.
VIG has outperformed the SPDR S&P 500 (NYSE: SPY ) over the past 12, 24 and 36 months while being less volatile than SPY over all those time frames. In the past year, VIG is up 16.2 percent compared to 15 percent for SPY.
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