A Defensive, Low-Cost Dividend Growth ETF

The fund tracks the Nasdaq U.S. Dividend Achievers Select Index, which includes stocks that have increased their dividend for at least 10 consecutive years but excludes REITs and other companies that have low potential for dividend growth. Unsurprisingly, the fund has seen a drop in its energy exposure as oil prices have slid, from almost 10% of assets in March 2014 to 1% in March 2016.

The fund's focus on firms that are financially healthy enough to grow their payouts favors highly profitable companies with durable competitive advantages. Relative to the S&P 500, the fund sports higher returns on equity, assets, and invested capital. Those traits can come at a premium, and the fund does look pricier than the S&P 500 on traditional metrics such as price/earnings and price/book as of April 2016.

However, the fund's quality tilt has helped it shine during market downturns. For example, it held up better than the S&P 500 and landed in the top decile of the large-blend Morningstar Category in the rocky market environments of 2008 and 2011.

The fund just hit its 10-year mark on April 27. During that period, it's had low tracking error relative to its stated benchmark while performing competitively relative to its large-blend category peers and a subset of funds focused on dividend growth. It hasn't beaten its actively managed sibling,

Fundamental View While most dividend-themed funds end up with a value tilt and a higher dividend yield, this fund falls in the large-blend category and has a dividend yield in the same ballpark as the S&P 500. However, the fund tends to invest in higher-quality companies. The fund has a greater percentage of assets in stocks with Morningstar Economic Moat Ratings of wide (58% as of March 2016 to the S&P 500's 50%). In addition, its companies have higher returns on invested capital, returns on assets, and returns on equity than the S&P 500. These characteristics usually do not come cheap, and the fund's holdings currently trade at slightly higher multiples of earnings and book value than the S&P 500.

The fund's 10-year dividend growth requirement is a tough hurdle to clear. If a company doesn't continue to raise its dividend, it is out for at least a decade. And while the fund's index applies some proprietary filters to screen for dividend sustainability, its selection approach is primarily backward-looking. Some of its holdings may not be able to sustain their dividend growth as business fundamentals change, but most of the holdings that make the cut enjoy strong profitability and durable competitive advantages that may help them weather market downturns better than their peers. Top holdings currently include

Compared with the S&P 500, the fund has larger stakes in the industrials and consumer staples sectors and less exposure to the financials, energy, and technology sectors. The fund's energy stake has dropped as oil prices have plunged and energy-related companies have come under financial pressure and in some cases cut their dividends, keeping them from being included here. Energy stocks comprised 10% of assets in March 2014 but just 1% in March 2016.

Unlike pure yield-focused strategies, this fund reduced its exposure to financials leading up to the 2007-09 financial crisis. Holding a smaller financials stake, along with its high-quality portfolio, helped buffer it, with the fund's 26% decline ahead of the S&P 500's 37% loss in 2008. Overall, the fund has captured less than 80% of the S&P 500's losses in down markets since inception.

On the flip side, it can lag in bull markets, as is often the case with dividend-focused funds. Its three- and five-year results through April only look average relative to its broad category. However, its long-term risk-adjusted returns are compelling.

While the fund has posted strong results relative to many actively managed dividend growth funds, it hasn't topped its Gold-rated sibling, VDIGX. As an actively managed fund, VDIGX has more flexibility than this fund, such as buying an attractively priced dividend-paying stock even if it lacks 10 years of dividend increases.

Portfolio Construction The fund tracks the Nasdaq U.S. Dividend Achievers Select Index. This index is a subset of the Nasdaq U.S. Broad Dividend Achievers, which screens for U.S. stocks that have increased their regular dividend for at least 10 consecutive years and meet minimum liquidity requirements. From this broader list of stocks, the Dividend Achievers Select Index excludes REITs and limited partnerships and applies other proprietary screens to arrive at a final list of 140-190 constituents. While those additional screens are not disclosed in detail, they appear to look for dividend sustainability and exclude companies that have low potential for dividend growth. The results are market-cap-weighted, but stocks typically don't comprise more than 4% of the index. The index is reconstituted annually.

Fees This fund charges a 0.10% expense ratio, which makes it one of the cheapest dividend ETFs available. Its estimated holding cost, which measures the difference in performance between an ETF and its benchmark, was 11 basis points for the trailing year through April. Overall, the fund has efficiently tracked its index.

Alternatives

Investors looking for equity income might consider

Investors might also consider actively managed VDIGX, which offers a similarly high-quality portfolio, has a more flexible strategy, and is still reasonably priced at 0.33%.

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