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3 Excellent Dividend Growth Funds and ETFs

Dividend-growth strategies tend to hold up well on the downside--an important attraction in 2020's volatile market.

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Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

The year 2020 has been tough on some dividend-focused strategies. A broad swath of companies has been forced to cut dividends in the wake of the coronavirus pandemic, and their share prices have taken a hit, too. As a result, even elite funds that prioritize companies paying high dividend yields, like Vanguard High Dividend Yield (VYM), have lost more than the broad market thus far in 2020.

By contrast, dividend-growth strategies have fared relatively better, and may continue to do so if the recession drags on, too. Such strategies typically focus not on companies with dividends that are high in absolute terms but rather a history of growing their dividends over time. Because their dividends aren’t high as a percentage of their profits, companies with growing dividends are less likely than high-dividend payers to slash dividends in weak economic environments. In addition, dividend-growth companies have often been more resilient than “yielders” in periods of broad-market weakness. In the first quarter of 2020, for example, Nasdaq U.S. Dividend Achievers Select, an index focused on dividend growers, lost less than high-yield indexes like the FTSE High Dividend Yield, and the companies in the Nasdaq index experienced fewer dividend cuts, too. The trade-off, however, is that dividend-growth strategies are not high-yielding in absolute terms; in fact, yields are often no better than that of the broad market.

Investors interested in working with dividend-growth names can do so in a couple of different ways. One is to buy the individual stocks directly. Doing so requires homework and you may incur trading costs, but you'll avoid management fees and be able to focus on your highest-conviction names. Alternatively, you can go with an actively managed fund or an ETF or traditional index fund focusing on dividend growth stocks. Here's a short list of some of Morningstar analysts' favorites.

T. Rowe Price Dividend Growth (PRDGX)
Morningstar Category: Large Blend
Morningstar Analyst Rating: Silver
SEC Yield: N/A

Manager Tom Huber has been in charge here for two decades, following a consistent approach that focuses on competitively advantaged, shareholder-friendly firms that appear likely to grow or at least maintain their dividends. Like the best dividend-growth funds, this one has been a reliable performer on the downside, thanks to its focus on high-quality dividend payers and avoidance of speculative names. For example, it lost less than the S&P 500 during the February/March market swoon this year. As an actively managed fund, it's obviously more expensive than index-focused competitors, but its fees are below average relative to its category peers.

Vanguard Dividend Appreciation (VIG)/(VDADX)
Morningstar Category: Large Blend
Morningstar Analyst Rating: Silver
SEC Yield: 1.88% (VIG, as of 6/30/2020)

This passive fund is the largest equity holding in my mutual fund and ETF bucket portfolios, which are geared toward people already in retirement. Like the aforementioned funds, its yield isn't impressive in and of itself, but its focus on companies that have increased their dividends in each of the past 10 years has helped keep a lid on volatility relative to the broad market. True to form, it outperformed the S&P 500 and total market indexes during the bear market in the first quarter, though it has lagged them for the year to date. Its yield hurdle means that it gives short shrift to certain sectors where dividends are less central, such as technology; that has crimped returns relative to the broad market over the past decade, as fast growth has led the way. Thanks to its low costs and sound strategy, the fund remains a top pick for investors who want to own stocks with a bit less volatility than equities at large.

Vanguard Dividend Growth (VDIGX)
Morningstar Category: Large Blend
Morningstar Analyst Rating: Gold
SEC Yield: 1.87% (as of 6/30/2020)

This fund is one of Morningstar’s highest-conviction picks in the whole dividend space, and it reopened to new investors last summer after closing three years prior. Donald Kilbride focuses on companies with a history of growing their dividends, like its index-fund counterpart Vanguard Dividend Appreciation. But Morningstar strategist Alex Lucas points out that Kilbride and his Wellington Management team are able to identify opportunities that a simple screen wouldn’t necessarily capture. Lucas points out that the fund’s ability to lose less than its peers and the S&P 500 in periods of equity-market weakness has played a huge role in its terrific long-term track record.

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

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