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ETF Specialist

A New Dividend ETF for Schwab, but Has This Trade Become Crowded?

Dividend ETFs have become very popular with investors, but is the group overvalued?

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Dividend-themed exchange-traded funds have been a popular choice among investors over the past year. The 42 dividend-themed ETFs that we follow raked in $16 billion in flows, nearly a third of every dollar going into equity ETFs, despite the fact that they make up just 5% by count of the 812 equity ETFs available. With the dividend yield on the S&P 500 Index at 2.1%, well above the 1.7% yield on the Barclays Aggregate Bond Index, who could blame investors for looking to equities? But be cautious when hunting for yield, particularly when moving up the risk ladder from bonds to stocks. Over the past five years, the average dividend ETF has had a volatility of 23%, more than 6 times greater than the 3.6% volatility of the Barclays Aggregate over that same time period. The highest-yielding stocks are more volatile than stocks in general, so dividend ETF investors should consider the stock-selection process employed by the fund. One ETF that gets it right is  Schwab U.S. Dividend Equity ETF (SCHD), one of the most successful ETF launches of the past year. While we like the approach of this fund, the valuations in some defensive sectors have become stretched. In addition, investors often pile into popular funds at the wrong time, as my colleague Adam Zoll outlines here.

Suitability
Schwab U.S. Dividend Equity ETF is a suitable core holding for investors that want a focus on dividend-paying stocks and are comfortable with the large-value tilt this fund provides. This ETF holds 100 stocks that meet various criteria, including 10 years of consistently paying a dividend and a high composite score on a four-factor model of financial strength. Perhaps most important, it follows an adjusted market- cap-weighting approach, which results in a tilt toward large-value companies. Because of this tilt, investors should be aware of how this portfolio might overlap with existing portfolio holdings.

Michael Rawson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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