Is There a Bubble in Dividend ETFs?

ETF Trends

More than $10 billion has flowed into dividend exchange traded funds so far this year and now some analysts are talking about a potential bubble in income-producing stocks and ETFs.

For example, WisdomTree Emerging Markets Equity Income (DEM) and Vanguard Dividend Appreciation (VIG) have each seen more than $2 billion move in the door in 2012. [Why Dividend ETFs Remain Popular]

However, Michael Clarfeld, portfolio at ClearBridge Advisors, tells Morningstar he doesn’t think there is a bubble in dividend stocks, although some traditional income sectors are becoming slightly overvalued.

Many popular dividend stocks are established, very large-cap companies.

“So, it’s not a small segment. The idea that some people who are starting to allocate money there are going to really change the pricing in the marketplace sort of surprises us,” he said. “More importantly I guess the answer is we do see a few areas of dividend stocks where we see some higher-than-expected valuations. We think particularly at the highest-yielding end of the spectrum–on the utilities side or with telecom–we think some of those are a little richly valued.”

In dividend ETFs, some of the other largest funds include iShares Dow Jones Select Dividend Index Fund (DVY), iShares High Dividend Equity Fund (HDV), SPDR S&P Dividend ETF (SDY), Vanguard High Dividend Yield Index Fund (VYM), WisdomTree Dividend Top 100 Fund (DTN), PowerShares International Dividend Achievers (PID) and First Trust Morningstar dividend Leaders (FDL).

Clarfeld, a co-manager at ClearBridge Equity Income Builder Strategy, says his team is more focused on compounding dividends over time.

“We believe the power of dividends is not simply the upfront yield. But it’s the combination of the upfront yield and the ability to grow that dividend over time,” he told Morningstar. “And what we see today, where we find the most attractive investment opportunities, is in high-quality dividend payers–companies that might be paying 3%, a nice yield, but not astronomical, but can grow that at 7%, 8%, or 9% a year.”

Josh Brown at the Reformed Broker blog recently wrote that aside from high dividend payers, investors should focus on companies that are growing their dividends at high rates. [Dividend ETF Yield Even More Critical in Sideways Markets]

“Is there a bubble in dividends? We think some of the highest-yielding components of the market from a dividend perspective do seem maybe a little fully valued,” Clarfeld added. “But the sweet spot of what we look for–which is significant dividends, attractive dividends, but really dividend growers–we don’t think they are overvalued at all. We continue to think they are very attractively valued and set up to do very well for the foreseeable future.”

Full disclosure: Tom Lydon’s clients own DVY.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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