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Can Dividend ETFs Outperform Again After Stellar 2011?

tlydon@globaltrend.com (Tom Lydon)

Dividend-themed exchange traded funds outperformed in 2011 but are lagging the overall market so far this year with investors favoring growth sectors rather than dividend payers.

Dividend ETFs were all the rage last year due to low bond yields and a desire for safety in an uncertain market.

Some analysts are predicting dividend ETFs will have another year of stellar performance, similar to what was seen in 2011. [ A Quartet of Dividend ETFs ]

Going back in history, since 1927 high-dividend-paying stocks have returned about 11% per year, higher than the average 8% that was gained by non-dividend paying companies, reports Michael Rawson for Morningstar .

Why should dividend ETFs outperform again in 2012? For one, stocks are offering a better relative value than bonds, explains Rawson. Furthermore, large-cap quality stocks are selling at a discount compared to small-caps right now. The larger companies can handle the slower economic growth that is forecast for the U.S. economy into this year. [ ETF Chart of the Day: Dividend Funds ]

“The reality of the U.S. employment picture is that it may be a very long time before the people who long for a ‘daily grind’ get the opportunity again. Without a better participation rate, the U.S economy and other developed world economies will see undesirable slow economic progress,” Gary Gordon wrote on Seeking Alpha .

Morningstar prefers large-cap stocks compared to the riskier small-caps that tend to be more expensive and are vulnerable in slow growth climates. Dividends can provide support in a low-return market.

“If there’s good news for investors, it’s the fact that leaner, meaner, multi-national corporations can still be quite profitable, selling their products and services in emerging nations,” Gordon wrote. [ ETF Focus: Dividend ETFs in 2012 ]

Morningstar recommends the following dividend ETFs:

  • Vanguard High Dividend Yield Index ETF (NYSEArca: VYM - News ) The ETF is low-cost and diversified, making it a good core holding. The slant is toward large-cap, value companies.
  • Vanguard Dividend Appreciation ETF (NYSEArca: VIG - News ) This ETF is known for its stability. Companies in this ETF have to had increased dividends for the past 10 years.
  • WisdomTree DEFA (NYSEArca: DWM - News ) This fund is a “stable” overseas focused fund that highlights high-yield. The index is weighted by the amount that is paid in dividends, so the focus is on large-caps.
  • PowerShares FTSE RAFI US 1000 (NYSEArca: PRF - News ) Although the ETF is not dividend-focused, the index considers cash flow, book value and sales, along with dividends, for the companies included.

Vanguard Dividend Appreciation ETF

Tisha Guerrero contributed to this article.