VYM - DHS And VYM: They Lost Me At Hello - Investors Can Do Better Than These Overpopulated Dividend ETFs

2023-12-22 05:38:25 ET

Summary

• Wisdom Tree U.S. High Dividend Fund ETF targets high-yielding U.S. large-cap domestic companies, providing a 4.5% dividend yield.
• Companies that establish and grow their dividends offer defensive advantages, such as lower volatility and earnings resilience.
• Potential tailwinds exist for this fund and VYM, but both hold too many stocks to meet my criteria for solid dividend ETFs.

After the past 2 years, a few areas of the stock market emerge as worth devoting significant research time to. One is dividend stocks. But I try to keep the bar high, and so I'm looking for more than just a high yield. I seek total return, and low volatility. To find what I seek, I expect to "kiss a lot of frogs" in the research process. Because this is not 2016, when dividend investing was hitting a prime period, and companies were fundamentally solid.

These days, a lot of stocks that pay high yields are a mess under the hood. Fortunately, some good companies' stock prices have been thrown out with the ugly ones, and that should facilitate the search process. Here, I'll focus on two dividend ETFs that epitomize what I don't like in that sector, and thus are being eliminated from consideration for my "short list."

I grouped them together because I see similar issues with them that detract from their appeal. While both funds started during 2006, one is now a giant, $60 billion ETF overseen by an industry icon, and the other a $1.1 billion fund managed by another very established manager.

In both cases, I think their offerings amount to very little value added. As I continue to update my research on the dividend ETF space, I will have more positive things to say about a select number of players in the high yield stock peer group. The 2 funds are the giant Vanguard High Dividend Yield Index Fund ( VYM ) and the relatively smaller Wisdom Tree U.S. High Dividend Fund ETF ( DHS ).

Why they lost me at "hello," the opposite fate of Tom Cruise's character in the movie "Jerry Maguire."

Both of these ETFs make dividend investing unnecessarily complicated. I believe that when scouting dividend funds (I used to manage a dividend mutual fund, so I'm not speaking from lack of experience), the ideal situation is where a shareholder can look at it and immediately say, "that's a lot like what I'd do if I were setting up my own dividend stock portfolio." But instead, these 2 funds own several hundred stocks. VYM has around 450 and DHS close to 400. The benefits of diversification are lost way before then.

VYM: Too big to succeed

Since VYM is better known, I'll simply say that I think investors can do better, with fewer holdings, if they merely look beyond the Vanguard name. It is not that big fund companies do not have some strong ETFs in their arsenal. But when a fund is $60 billion, it crowds out a lot of potential flexibility and differentiation, rendering it essentially an S&P 500 ETF minus the big growers that don't pay a dividend.

DHS: Missing a chance to differentiate

DHS targets exposure to high-yielding U.S. large-cap domestic companies. It positions itself as a complement or replacement of similar active and passive ETFs for investors looking for growth and income. The ETF is comprised of roughly 385 companies currently providing a 4.5% dividend yield.

Its sector allocations are the usual dividend suspects with energy, financial, utilities, health care and consumer staples representing roughly 75% of the ETF. Large-cap companies in these sectors are mature companies with seasoned management teams that pay dividends consistently with a dividend growth rate. But the fund suffers from too much of a potentially good thing. The portfolio trades at under 13x trailing earnings, but I don't think it is the first place to look for the concept noted above: a dividend ETF that looks like a stock portfolio one might research and own by themselves.

Here are the 2 ETFs side by side. DHS has consistently yielded more, so I do favor it over VYM, since one of my other key historical patterns to track (rolling standard deviation) is close enough to call a draw.

While large-cap dividend yield strategies like DHS tend to be defensive in nature, the excessive diversification invites way too much drek to mix in with the quality, sustainable yielders that a best of breed dividend ETF should center on.

There are some unique potential tailwinds in the 2024 landscape that could accelerate the performance of dividend ETFs, and these 2 funds should tag along. But are they best of breed? No.

The Inflation Reduction Act of 2022 (IRA) is one potential booster for dividend ETFs. This government program offers significant tax subsidies for decades for companies involved in ambitious infrastructure investments related to carbon capture, green energy growth, liquid natural gas ((LNG)), electric grid expansion, and EV charging stations among others. 34% of companies in DHS are in the energy, utility, and pipeline sectors set to gain from the IRA, which will start to ramp up in the new year.

The Fed's more dovish tone, set by Chairman Jerome Powell in last week's meeting, combines with the US Presidential election year of 2024 to put history on the side of dividend stocks. That is, rate hikes will be a longshot, and rate cuts, though less likely than many think in my view, are at least convincing the market that stocks are still attractive.

To be clear, I don't think VYM and DHS are awful investments. I just don't see them as adding alpha in a muddy US equity market, which is my expectation for the next several years. I can't think of any ETF holding 400 stocks that would, beyond using it as a trading vehicle.

2 for the "no" pile for this dividend investor

This is a time in market history that will likely favor a combination of flexibility, adapting to the uniqueness of post-pandemic investment markets, and doing diligent research to identify ETFs that hold the stocks that will deliver yield, stability and a dearth of negative surprises. That is a lot easier to do by scouting more concentrated ETFs, and the 2 reviewed here don't qualify on that count.

They get Hold ratings from me because I think nearly any dividend-driven fund that goes beyond mega-cap tech stocks will hang in on a relative basis to the broad market. But when it comes compiling my short list of dividend ETFs for a potentially powerful period for that market segment, VYM and DHS just don't cut it for me.

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