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How CLS Investments Is Getting Strategic With Dividend ETFs

This article was originally published on ETFTrends.com.

In 2018, U.S. dividend growth remained solid, although some dividend exchange traded funds (ETFs) were challenged by the Federal Reserve's four interest rate hikes.

The “average Q4 2018 dividend increase in the S&P 500 was 10.24 percent, down from 10.41 percent during Q4 2017; 2018 average is 13.48 percent, up from 2017’s 11.36 percent,” according to S&P Dow Jones Indices.

Expectations are in place that the Fed will slow its pace of rate hikes this year or possibly not raise rates at all. Even with that more sanguine interest rate outlook, how investors approach dividend ETFs this year matters.

Joe Smith, deputy chief investment officer (CIO), at CLS Investments ($9.2 billion AUM), recently discussed his firm's approach to dividend strategies with ETF Trends.

"At CLS, we offer a number of Risk-Budgeted ETF strategies that seek consistent reliable distributions from a variety of traditional and non-traditional income producing areas, including dividends,” said Smith. “These strategies are designed to source income across multiple asset classes including equities and bonds while providing additional opportunities for growth over time.”

Growth Vs. Yield Debate

When the Fed tightened rates last year, some high dividend strategies languished while dividend growth ETFs performed less poorly. With the Fed poised to potentially not boost borrowing costs at all this year, Smith sees opportunities for dividend investors with both dividend growth and high-yield ETFs.

“We think that both high dividend yield ETFs and dividend growth ETFs will both thrive for now assuming the Fed is on pause with interest rate hikes,” said Smith. “Although dividend paying companies historically have been associated sectors more sensitive to movements in interest rates, we also see the availability of dividend income coming from more non-traditional dividend-paying sectors including technology.”

Among the dividend ETFs that CLS uses are the iShares Core High Dividend ETF (HDV) , which tracks the Morningstar Dividend Yield Focus Index, and the First Trust NASDAQ Technology Dividend Index Fund (TDIV) . TDIV tracks an index of technology dividend-paying stocks. Underlying components have paid a regular or common dividend within the past 12 months, with a yield of at least 0.5%, and have not had a decrease in dividends per share within the past 12 months.

Companies that have consistently increased dividends tend to be high in quality and show a strong potential for growth. These dividend growers have been able to withstand periods of market duress, exhibiting smaller drawdowns as investors sold off riskier assets, while still delivering strong returns on the upside, to generate improved risk-adjusted returns over the long haul.

"We believe that in the current environment, it is important for investors to not just focus on the highest dividend yielders, but invest in ETFs that also account for the safety and likelihood of the companies it owns to continue to pay and increase their dividends,” said Smith.

Still, a defensive strategy such as HDV could be beneficial to investors this year.

Assuming we continue to see a bit of a pause in earnings growth in 2019, we expect more defensive oriented sectors such as consumer staples and health care to drive dividend growth in the near-term,” notes Smith.

HDV allocates over 37% of its weight to consumer staples and healthcare stocks. Those are the second- and third-largest sector weights in the fund.

Small-Caps, Too

In recent years, the small-cap arena has become increasingly fertile ground for dividend investors, but yields remain low on traditional small-cap benchmarks.

Analysts expect firms in the benchmark Russell 2000 index to generate double-digit profit gains throughout 2019. Profits across the Russell 2000 is expected to grow by almost 16% over the first quarter year-over-year after the 12.6% earnings growth rate expected in the final three months of 2018. Some even project the the small-cap benchmark to see profits surge to over 30% year-over-year in the fourth quarter of 2019.

The WisdomTree SmallCap Dividend Fund (DES) is one of the ETFs CLS uses to gain exposure to small-cap dividend payers.

DES, one of the foremost names among small-cap dividend ETFs, follows the dividend-weighted WisdomTree U.S. SmallCap Dividend Index.

Mid- and small-cap dividends can present additional opportunities for investors looking for income and also have a greater tolerance for risk in their portfolios,” said Smith of CLS. “We see value in the use of ETFs like DES as a great way to access dividend related income from higher quality mid- and small-cap stocks.”

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