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A Friend In The Fed For This Dividend ETF

ETF Professor

Speculation that the Federal Reserve could lower interest rates this year and the corresponding declines in Treasury yields are positives for myriad asset classes including dividend stocks, particularly those of the high-yield varietal.

Just look at the iShares Core High Dividend ETF (NYSE: HDV), which is higher by more than 5% over the past month, a period including the Fed's most recent meeting.

What Happened

The $7.32 billion HDV tracks the Morningstar Dividend Yield Focus Index and holds 74 stocks. HDV yields 3.46%, or 158 basis points above the dividend yield on the S&P 500.

HDV's “underlying index is comprised of qualified income paying securities that are screened for superior company quality and financial health as determined by Morningstar, Inc.’s proprietary index methodology,” according to Morningstar.

Why It's Important

Income investors should consider the current environment, meaning where dividend stocks are out and where the group has been.

“High dividend yield seeks to provide exposure to above average dividend-paying companies relative to price, while dividend growth aims to invest in companies that consistently grow their dividends,” said BlackRock in a recent note. “Following the Global Financial Crisis many dividend-oriented funds employ quality screens as part of their investment process.”

While HDV is a high dividend strategy, the fund is not excessively allocated to the utilities and real estate sectors, groups that are often pillars of high-yield dividend ETFs. Those sectors combine for just 10% of HDV's roster.

“Companies within sectors such as Consumer Staples and Utilities for example, can afford to pay more of their earnings out in the form of dividends; they are generally more established, have high barriers to entry, and are less focused on reinvesting for rapid growth,” said BlackRock.

Energy is HDV's largest sector weight at 24% followed by consumer staples at 19%, according to issuer data.

What's Next

The sanguine interest rate outlook should continue serving as an impetus for income investors to embrace funds like HDV.

“Higher rates have historically put pressure on dividend strategies,” said BlackRock. “Dividend-paying companies tend to carry more debt, which grows more expensive as rates rise; at the same time, bond yields become more attractive as interest rates rise, lowering the demand for income through dividend-paying stocks.”

Fortunately for HDV, higher rates do not appear to be in the cards this year.

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Photo credit: Dan Smith - Own work via Wikimedia Commons

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