Vanguard High Dividend Yield Aims for Stability

Vanguard High Dividend Yield VYM strikes a balance between higher yield and the inherent risks. Weighting stocks by market cap steers the fund toward more stable, large-cap stocks and away from those whose dividends may be distressed. Its consistently strong risk/reward profile underpins its Process Pillar rating upgrade to High from Above Average.

This fund tracks the FTSE High Dividend Yield Index. It starts with large- and mid-cap stocks in the FTSE USA Index, excluding REITs, and ranks them by their expected dividend yield over the next 12 months. The index selects those representing the higher-yielding half of eligible dividend-paying stocks. Selected holdings are weighted by float-adjusted market cap, pulling the portfolio toward larger, more stable stocks.

Focusing on dividend yield gives the portfolio a value orientation that can open the portfolio to risk. Value traps, or stocks with deteriorating fundamentals and declining prices, pose a significant risk to dividend funds. But this strategy limits its exposure to risky companies. Sweeping half of the dividend-paying universe into its portfolio diversifies stock-specific risks and limits the influence of distressed firms. Market-cap weighting also emphasizes larger, more stable firms that should have the capacity to continue making dividend payments. This mitigates the impact of value traps because their weight drops as prices fall.

Leaning toward stable companies comes at the cost of maximizing dividend yield. But the fund’s yield of 3.10% still surpassed the Russell 1000 Value Index by over 1 percentage point as of August 2023. Stability extended to performance as well, with the fund experiencing a five-year standard deviation 8% lower than its category bogy.

Similar to other dividend-focused funds, this fund’s sector composition can deviate substantially from the category index’s, owing to its yield orientation. Market-cap weighting normally keeps these differences small, but the fund’s yield screen can still exclude a significant portion of the market in extreme conditions. Between 2010 and 2018, for instance, the fund’s allocation to financial stocks was anywhere from 15-20 percentage points below the category average. This is an artifact of the post-financial-crisis dividend cuts across much of the sector. While this did not hurt the fund’s performance significantly, sector bets tend to be an uncompensated risk.

This fund’s cost-conscious approach sets it apart from the crowd. The 0.06% fee for its exchange-traded fund share class is among the lowest in the large-value Morningstar Category.