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ETF Specialist

Dividend ETFs 2.0

The new breed of dividend-themed ETFs offer some improvements, but our old favorites are still worthy of consideration.

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Dividend-focused exchange-traded funds that offer a decent yield and instant diversification have been wildly popular in recent years, thanks to the paltry yields in fixed income. To satisfy investor demand, ETF providers have launched a slew of new products. Many of these ETFs offer more intelligent designs than the first generation of dividend-focused ETFs. The improvement in structure is in response to some flaws in some of these older ETFs. Here we will discuss some of these flaws and highlight the new ETFs that we like.

According to data from Ken French's website, dividend payers have outperformed nonpayers over the past 85 years. If we sort the dividend payers into five quintiles, we find that the highest-yielding bucket, quintile 5, does not have the highest return or highest risk-adjusted return--that distinction belongs to quintile 4. In other words, reaching too far for yield can lead to suboptimal results. This suggests that, with appropriate screening, we can build a better dividend fund than one that naively buys just the highest-yielding stocks.

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