2023-03-16 09:34:44 ET
Summary
- DVY tends to be a more defensive ETF given its objective to hold high dividend paying stocks. This offers investors exposure to Utilities, Financials, Energy, and Consumer Staples disproportionately.
- Normally, I would see recent market volatility as a reason to own and/or buy DVY. But with the Financials sector being the culprit for the sell-off, I would approach cautiously.
- The fund's dividend yield looks good if we consider both the Q4 payout growth and the easing of inflation. This supports why this fund is not a "sell" here.
Main Thesis & Background
The purpose of this article is to evaluate the iShares Select Dividend ETF ( DVY ) as an investment option at its current market price. The strategy of this fund is " to track the investment results of an index composed of relatively high dividend paying U.S. equities".
I wrote about DVY back in Q4 and suggested investors consider this fund but do so cautiously. In hindsight, this caution made sense as the fund has seen a dip since that time during a period of market volatility:
Given this weakness, I thought it may be time to upgrade this fund to a "buy" on the pullback. However, I am concerned about the reasons behind the drop in price and see an environment where being vigilant still makes sense. Therefore, I will use this review to reiterate my "hold" rating and I will explain why in detail below.
As A Dividend Play, It Looks Good
To start the review I want to emphasize why DVY remains on my radar screen. As a "dividend seeker", I am always on the find for quality dividend-paying stocks and funds. From this perspective, DVY fits the bill because it has a yield in excess of 3.5% right now:
While I admit this is not "high", it is reasonable compared to many other dividend ETFs built on equity positions. Furthermore, the fund saw aggressive dividend growth in Q4 on a year-over-year basis:
2021 Q4 Distribution | 2022 Q4 Distribution | YOY Growth |
$.84/share | $1.04/share | 23% |
Source: iShares
I view this as confirmation this remains a reasonable way to gain quality dividend growth and act as an inflation hedge. While inflation has been coming down of late, it is still at an elevated level. This makes inflation-oriented investing as relevant today as it has been for the past few years:
I am using this as an exercise in why I don't see a compelling "sell" argument here. DVY remains a quality dividend play with a growing yield in a high inflation environment. This offers investors some relative comfort in what is shaping up to be a volatile Q2 ahead.
Holdings Mix A Mixed Bag
I will now shift to the underlying holdings of the fund. In normal times I really like DVY's mix. It is light on Tech and heavy in other areas like Utilities that are light in the S&P 500 index. This makes it useful for portfolio diversification. Further, Financials are a sector that I would typically want in a rate-hiking cycle, like the one we are in now:
So, what's the problem? I doubt I need to go in to too much detail here because I'm sure most investors know the problem at the moment! Suffice to say recent bank failures and generally market sentiment have been pressuring the banking sector disproportionately. I personally see this as a bit overblown, but overblown reactions can take a long time to calm down. Unfortunately, that is shaping up to be the case here. Consumer sentiment is in a freefall and investors are left wondering when the "bottom" is going to be in for the sector:
The simple reality is this makes investing in Financials/Banks difficult at the moment. Can we expect a rebound tomorrow, next week, a few months from now? That is a complete unknown. While I stated I think investors are overreacting, that suggests I view this sector as a buying opportunity. That is true, in part, but only if one can withstand elevated volatility. For someone, like myself, that already has Financials exposure, perhaps adding now is not the best option. It really depends on your risk tolerance and forward outlook, which is clouded by the fact that market is acting a bit irrationally.
The takeaway for me is that DVY's Financials weighting gives me some pause. Over the longer term this is a fine allocation. But for the short term, this 19% exposure is likely to rock the boat, supporting my "hold" thesis.
Energy Sell-Off A Good Opportunity
Of course, Financials are not the only sector within DVY. This is a fairly diversified portfolio. As my followers know, I am a Utilities' bull at this juncture. I won't go in to a lot of detail on that here since I recently covered the idea in an article on the Vanguard Utilities ETF ( VPU ). I don't want to spend a lot of time rehashing what was published not long ago.
Instead I will take a look at the Energy sector because that makes up over 10% of DVY's total assets. I think this is a good add to any dividend play because Energy companies in recent years have been committed to returning cash to shareholders. This has occurred via buybacks and, of course, hiking dividend payouts.
For perspective, consider the following graphic. It shows that the Energy sector has been delivering a historically large amount of cash to its shareholders via both the methods mentioned above:
This is precisely the kind of management action I want from the companies I own stock in. This sector was a welcomed saving grace in 2022, and I see the time as being ripe for increasing exposure to this area.
Why now? Well, just look at the price action of the sector. All three energy funds I track closely - which include market-cap weighting (the Vanguard Energy ETF ( VDE )), equal weighting (Invesco S&P 500 Equal Weight Energy ETF ( RYE )), and international (iShares Global Energy ETF ( IXC ))- are down big in rapid fashion:
Is there more downside ahead? Possibly, depending on the forward outlook for the economy. Coming out of the current banking crisis, I am not going to suggest there is no risk here. But I love buying long-term holds during times of market stress that look unjustified. Just because a bank failed in Silicon Valley doesn't mean the global demand for oil is going to sharply drop. If anything, we could see a rotation in to crude oil and other energy plays as a market hedge for the commodity exposure. Either way, I think the sector is a buy on this correction, and DVY offers readers one way to play it.
Dividends Are Important For Total Return
A final point on DVY relates back to its "dividend" objective. It is no secret this is a strategy I favor - whether through DVY or any number of similar dividend-focused ETFs and CEFs. But the key attribute to emphasize here is why this is the case for me.
For illustrative purposes, let us then consider how important dividends can be to total return. Over time, dividends have provided a key source of returns for long-term investors, with the percentage spiking markedly during periods of volatility and general stress:
This is not a cure-all for market turmoil. Dividends alone cannot stem the tide of a rapidly falling index - such as what we are seeing play out this week!
But the takeaway I draw is that dividends help to right the ship and provide a cushion. It is with this mindset why I think dividend plays are fundamental to my portfolio, and why I look to them for as buys during periods of uncertainty.
Bottom-line
DVY has seen a correction over the past month and that has placed in firmly on my radar. While this would normally be a reasonable buy signal, at this time I am not so sure. Part of the reason for the weakness is the fund's Financials exposure - and that is something that would continue to pressure total return. A rebound is "hopefully" forthcoming, but hope is not an investment plan.
For these reasons I suggest that "hold" continues to make sense for DVY. This will be one I continue to watch, and look to buy if we see the Financials sector settle. While I do like its top sector by weighting - Utilities - quite a bit, I will stick with VPU for the time being as the way to hold that area. Therefore, I believe readers should be very selective with new positions going forward.
For further details see:
DVY: I Like Dividend Plays, But Financials Exposure Reiterates Hold Rating