3 Unrated Large-Cap Dividend ETFs for Your Radar

A version of this article previously appeared in the July 2019 issue of Morningstar ETFInvestor.

Income-seeking investors have been flocking to dividend exchange-traded funds. Over the five-year period ended June 2019, investors poured $61.4 billion of new money into these funds. Their popularity has led to an expansion of the menu, which now features an equity-income strategy for every palate.

We currently assign Morningstar Analyst Ratings to 11 of the 40-plus dividend ETFs in the U.S. large-cap space. Here, I profile a trio of U.S. large-cap dividend ETFs from outside our rated universe that I think are worth keeping on your radar.

ProShares S&P 500 Dividend Aristocrats ETF NOBL As the fund's name implies, the constituents of its index are an elite class of dividend-paying stocks. The S&P 500 Dividend Aristocrats Index is made up of S&P 500 stocks that have grown their dividends for at least 25 consecutive years. A quarter-century of uninterrupted dividend growth is no small feat. As of the index's January 2019 rebalance, it had just 57 constituents. This group had an average of 41-plus years of consecutive dividend growth.

Stocks that make the grade are equally weighted. The index caps its exposure to any single sector at 30% and rebalances quarterly. These two facets of the methodology reduce idiosyncratic risk by mitigating large single-stock or -sector bets.

NOBL's bogy applies the most stringent screen on dividend resilience of any index fund on the market. Large-cap stocks with 25-plus years of steady dividend growth tend to enjoy economic moats: durable competitive advantages that allow them to generate steady cash flows and the confidence to share them with investors. Our equity research analysts have assigned Morningstar Economic Moat Ratings of either wide or narrow to stocks making up 80% of NOBL's portfolio.

The quality of the fund's holdings has shone through in its performance. From its October 2013 inception, it has held up better than similarly quality-oriented dividend funds during market corrections. Downside protection has come at the expense of upside participation, and in a market that has been trending positively since the fund's inception, it's little surprise that it has lagged broad-based market-cap-weighted index funds focused on U.S. large caps. Exhibit 1 contains selected risk statistics showing how NOBL has stacked up relative to its nearest peers within Morningstar's rated universe.

Equal weighting adds an interesting wrinkle to NOBL's risk profile. As you can see in Exhibit 1, though it has fewer holdings versus the field, giving each name the same weighting results in less single-stock concentration, as reflected in the percentage of assets soaked up by its top 10 holdings. That said, in some cases, equal weighting leads NOBL to have a larger stake in small-cap stocks than peers whose underlying indexes weight stocks differently. For example, as of the end of June, NOBL had five stock positions in common with Vanguard Dividend Appreciation ETF VIG and Schwab U.S. Dividend Equity ETF SCHD. In the case of larger-cap names like 3M MMM and Procter & Gamble PG, NOBL is relatively underweight--given that it weights stocks equally and VIG and SCHD weight stocks by market cap. On the flip side, NOBL has relatively larger stakes in smaller-cap names like Clorox CLX. As such, NOBL's income stream may or may not be disproportionately affected by potential dividend cuts among this group of common holdings than VIG and SCHD.

To date, NOBL's performance has been driven chiefly by stock selection. Given its dividend durability filter, it's not surprising that the fund's weighting to less-cyclical consumer defensive names is more than 3 times that of its category index, the S&P 500. The fact that its allocation to basic-materials and industrials stocks is a multiple of the category norm might raise eyebrows. It is in these corners of the market where its bogy's stringent screens have paid dividends (pun intended), folding in names like narrow-moat Air Products & Chemicals APD and wide-moat Cintas CTAS.

So what's not to like? The biggest knock on this fund is its 0.35% fee, which is a multiple of those charged by its closest peers. The fee looks even more out of step when considered against the fund's growth and current scale. Having amassed $4.5 billion in assets over just shy of six years, NOBL now ranks as the ninth-largest large-cap dividend ETF. It's unlikely a fee cut is coming anytime soon. ProShares--which is best known as a provider of leveraged and inverse products--has never reduced the fee of any of its long-only equity ETFs.

Final word: There's a lot to like about NOBL, but its fee is steep and to date has consumed much of its pre-fee outperformance versus its less costly competition. Nonetheless, it's worth keeping an eye on and would be more compelling at a lower price point.

First Trust Rising Dividend Achievers ETF RDVY If NOBL represents the equity-income aristocracy, RDVY can be seen as the ETF of the upwardly mobile dividend middle class. This fund's index, the Nasdaq US Rising Dividend Achievers Index, seeks out future dividend aristocrats.

RDVY's index starts with the broad Nasdaq U.S. benchmark index, first screening for liquidity. From there, it selects stocks whose trailing 12-month dividend payments were greater than they were three and five years prior. Also, stocks' most recent fiscal-year earnings must be positive and higher than they were three years ago. From there, the index turns an eye toward the sustainability of these stocks' dividends. To be included in the index, stocks' cash/debt ratios must be greater than 50% and their trailing-12-month dividend payout ratios cannot be greater than 65%. Stocks that pass these screens are ranked based on their trailing-five-year dividend growth, current dividend yield, and payout ratio. The 50 stocks with the best combined scores across these metrics (those with the most attractive combination of high dividend yield and growth and a low payout ratio) are added to the index. These stocks are weighted equally, and industry exposure is capped at 30%. The index reconstitutes annually and rebalances quarterly.

The resulting portfolio tilts toward faster-growing, more-profitable value stocks, falling just outside the blend column of the Morningstar Style Box. Its focus on names with strong recent dividend and earnings growth lends itself to pronounced sector concentration. At just over 28%, RDVY's allocation to tech stocks is nearly 3 times that of the Russell 1000 Value Index. This includes names like Apple AAPL and Nvidia NVDA, which are nearly two decades worth of dividends away from being eligible for inclusion in the likes of NOBL. RDVY also has a significant overweighting in financials. At just over 30%, the fund's allocation to financials stocks is nearly 8 percentage points higher than the Russell 1000 Value Index's. These stocks joined the fund's index as their dividends rebounded following the global financial crisis.

The juxtaposition between maturing growth stocks in the tech sector that are beginning to return cash to shareholders with dividends for the first time, and behemoth banks returning from the brink of death, reveals what I believe is a shortcoming in this index's methodology. The former group may be better positioned to continue to increase the amount of cash it returns to shareholders over the long haul. The latter cohort is trying to get back to where it began. In fact, two of RDVY's bank stock holdings, Bank of America BAC and JPMorgan Chase JPM, were once members of the S&P 500 Dividend Aristocrats Index. I think that a better option for those interested in zeroing in on truly emerging dividend achievers would be to exclude any stock that has ever cut its dividend. Doing so might help weed out firms that are secularly challenged or simply enjoying a cyclical rebound and isolate more on companies that are set up to leverage solid long-term fundamentals into growing payouts for their shareholders.

Final Word: I like the concept behind RDVY, but I believe its implementation could be marginally better. I think that a methodology that homes in exclusively on emerging dividend payers (leaving the re-emerging ones aside) would stand a better shot of boosting its payout over time. Also, like NOBL, this fund's fee is rich. Its 0.50% expense ratio was approximately equal to its net-of-fees underperformance versus Vanguard Total Stock Market ETF VTI from its inception through the end of June. All told, this is an interesting option for those looking for exposure to dividend up-and-comers (even though there may be some recent down-and-outers in this mix).

SPDR Portfolio S&P 500 High Dividend ETF SPYD Launched in October 2015, SPYD is a relative newcomer to the roster of dividend ETFs dabbling in U.S. large caps. In 2017, SPYD was included in SPDR's "Portfolio" lineup of ETFs, which feature prominently on TD Ameritrade's commission-free ETF list. At the time, the fund's fee was reduced to 0.07% from 0.12%. This made it one of the lowest-cost options among dividend ETFs focused on U.S. large caps.

Screening stocks based on dividend yield is risky business. A rising yield is often an indication that the market has soured on a firm's prospects. It may be hitting a rough patch, or it may be fundamentally impaired. Whatever the case might be, many investors don't want to stick around to find out and must accept lower prices from buyers in order to offload their shares.

In the case of the S&P 500 High Dividend Index, its yield orientation and absence of sector constraints result in significant sector bets, which could result in significant interest-rate risk. At just over 21%, SPYD's allocation to real estate stocks is more than 7 times greater than the S&P 500's. Its near-13% allocation to utilities stocks is nearly 4 times that of its selection universe. Both sectors are particularly interest-rate-sensitive and could face near-term headwinds during a period of rising rates.

The risks inherent in this strategy have generally been compensated for in the form of a materially higher dividend yield relative to comparable funds like Silver-rated Vanguard High Dividend Yield ETF VYM. Like SPYD, VYM sorts its universe on indicated yield. However, VYM's selection universe is significantly larger and excludes REITs. The result is a better-diversified, though lower-yielding, portfolio.

Final Word: Investors who are interested in a low-cost, high-income equity strategy and willing to assume the risks that come with a yield-centric approach should consider this fund.