The overwhelming consensus on Wall Street is that Treasury yields are heading higher this year, which could pinch some high-yielding asset classes. Those fears are being reflected in the performance of some sectors believed to be sensitive to interest rates.
Some rate-sensitive sectors are already scuffling. For example, the largest utilities and real estate exchange traded funds are down an average of 4.1 percent to start 2018, while the telecom sector is trailing the S&P 500 by a margin of more than 8-to-1. These trends could prove concerning for yield-based dividend ETFs, indicating that quality and dividend growth could be the factors to focus on.
The Schwab U.S. Dividend Equity ETF (NYSE: SCHD) is more of a quality/dividend growth idea than it is yield play. SCHD's dividend yield of 2.7 percent is only a few basis points more than investors get on 10-year Treasuries.
Better Than Focusing On Yield
The $7.1-billion SCHD tracks the Dow Jones U.S. Dividend 100 Index, which is not weighted by yield. Rather, that index requires member firms to have boosted payouts for at least 10 consecutive years. That methodology has advantages over yield-based strategies.
“This fund offers a low-cost portfolio of profitable stocks with attractive dividend yields,” said Morningstar. “This dual focus reduces the fund’s exposure to firms with weak fundamentals that may not be able to sustain their dividend payments, which is a risk that can accompany a narrow focus on yield. The fund’s sensible strategy and low fee should contribute to its edge over the long run.”
SCHD holdings are scored on cash flow/debt, return on equity, indicated dividend yield and five-year dividend growth. High dividend sectors such as telecommunications and utilities are minor parts of SCHD's sector exposure. Those two sectors combine for just 5 percent of the ETF's weight.
Tilting Toward Profitability
SCHD's focus on profitable companies that are good stewards of invested capital can help keep investors away from financially strained companies that could cut or eliminate dividends.
“The fund’s profitability tilt is evident. Its return on invested capital has been nearly double the category average since the fund’s inception,” said Morningstar. “Its ROE and return on assets have also been higher than the category averages since its inception.”
SCHD devotes 22.2 percent of its weight to the cash-rich technology sector, one of the largest technology weights among all dividend ETFs.
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