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Bet on Rising Dividends With This Financial ETF

As a majority of the companies finish reporting their quarterly financial results, it becomes a known fact that they have had a tough time increasing or even maintaining their revenues although profits more or less seem to be well aligned with market expectations.

While financials sector earnings have not been as good as in some of the previous quarters, the drag has mainly been a result of tough comparisons. Nevertheless, the financial sector has been delivering a decent earnings and revenue growth. Some of the noteworthy reasons are – marked decrease in provisioning for losses for banks and increasing fees for investment management firms. Mutual Funds and ETFs have witnessed massive inflows and increased trading activities facilitated by a surging equity market which have increased the brokerage fees for brokerage firms (see Are Low Volatility ETFs Capable of Big Gains?).

The impressive increase in earnings over the past few quarters has caused many of the companies from the financial sector to announce an increase in their dividends. Not only will this make financial stocks more attractive but it will also quench the dividend thirst for income seeking investors.

For investors seeking an exchange traded fund route to play the dividend paying financial equities the Powershares KBW High Dividend Yield Financial ETF (KBWD) would be an interesting choice.

KBWD was launched in December of 2010 and since then has been able to amass an asset base of around $244 million. The ETF follows a unique investment strategy and weighs its components, comprising of financial stocks, on the basis of their dividend yields.

Its portfolio comprises of approximately 37 stocks with just about 46% of its total assets invested in the top 10 holdings. One other noteworthy fact for KBWD is that it is mostly exposed to mid and small cap stocks as opposed to other mainstream financial sector ETFs which bet on the large cap ones.

At the first instance it might appear that a mid and small cap focused ETF might be more volatile compared to an ETF which concentrates on large caps, however this is not the case with KBWD. In fact KBWD has a three year annualized volatility of just 18.04%. Compared to this the Financial Select Sector SPDR (XLF) has a three year annualized standard deviation of 25.06% (see Time to Buy This Low Risk Retail ETF?).

This is primarily due to the fact that KBWD does not focus primarily on growth oriented stocks contrary to its financial sector counterpart XLF. Also, accounting for its relative capital market stability is the fact that it has a predominant exposure to dividend paying stocks which have low historical volatility measures.

Still, by no means does it imply that the ETF lags behind its other growth oriented counterparts. In fact a comparison of KBWD and XLF over a period of 3 years reveals that the dividend focused ETF has pretty much always been ahead of the growth oriented one as far as total returns are concerned (read What Does Your Income ETF Focus On?).

The following chart reveals the cumulative total returns between the two financial ETFs since the inception of KBWD back in December of 2010.

Chart 1: Comparative Total Returns Analysis

Notice how KBWD returns line has mostly been above the XLF returns line. Within this time frame, KBWD has returned almost 33% compared to XLF which returned 23.50%.

Thus, it is witnessed that even for a high volatility sector such as the financial sector, the low volatility ETF has outperformed the high volatility ETF in a slightly longer term picture.

The dividend yield for KBWD stands at an astounding 7.61%, but sadly investors have to pay a huge premium for the ETF in the form of the expense ratio which stands at 148 basis points. This is without doubt one of the most important factors which could restrict investors from owning this ETF.

Bottom Line

In the current low rate environment , any investment avenue which yields more than the benchmark rates is considered to be an attractive option. Considering this backdrop, KBWD fits the bill like no other ETF. However, investors have for long abstained from investing in financial stocks for dividends primarily due to the higher volatility attached with them (see Healthcare ETF in Focus on Earnings Reports).

However, we have already seen the risk-return tradeoff for this exciting ETF, which is pretty much in alignment with the risk tolerance of an income seeking investor. Moreover, with most of the financial companies increasing the dividends, now might well be the time to gain exposure in this exciting financial ETF.

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