Pairing Dividend Aristocrats With Bank ETFs

Income seeking investors know all about the dividend aristocrats. Those are the companies that have been raising their dividends for at least 25 straight years. They’re ideal for retirees and just about anybody else looking for dividend income in their portfolio because of their predictability. They’re not necessarily the highest yielding stocks but their steadiness is their real appeal.

Not surprisingly, one sector of the market that is essentially absent from the list of aristocrats is the banks. Any dividends they were paying were essentially wiped out during the financial crisis. Consider for a moment my favorite dividend aristocrat fund, the ProShares S&P 500 Dividend Aristocrats ETF (NOBL). As of the end of the second quarter, it had roughly 10% of assets in the financial sector. But look at who that 10% is comprised of - Aflac (AFL), T. Rowe Price (TROW), Franklin Resources (BEN) and Cincinnati Financial (CINF). That’s two insurance companies and two asset managers. Not a single bank to be found.

If you’ve followed the financial sector, you probably know that a month ago, the Federal Reserve approved the capital return plans of all 34 banks that it was reviewing as part of its Comprehensive Capital Analysis and Review (CCAR). Following the announcement, many of the banks unleashed plans for dividend increases and share buybacks. Citigroup (C) doubled its dividend, while Bank of America (BAC) raised its by 60%. Other big banks such as Morgan Stanley (MS), Wells Fargo (WFC) and JPMorgan Chase (JPM) all now have yields in the 2-3% range. Bottom line: Dividend seekers may have written off the banks, but it’s now time to put them back on the radar.

Investors who focus primarily on the aristocrats for income are likely missing out on the dividend growth potential that now exists in the banking space. Dividend Aristocrats ETF shareholders who want to add exposure to the financial sector may wish to pair the fund up with a financials ETF. None of the biggest financials ETFs yields more than 2%, so you won’t be getting a yield boost (unless you want to venture into riskier areas such as foreign or small cap banks). The main benefit is a more diversified income stream.

The largest of the financial ETFs, of course, is the Financial Select Sector SPDR ETF (XLF). It has about half of the fund invested in banks, but also has more than 40% of the fund invested in just five names - Citigroup, Bank of America, JPMorgan Chase, Wells Fargo and Berkshire Hathaway (BRK.A). The Vanguard Financials ETF (VFH) would be the low cost alternative. It has about 45% of the fund dedicated to both diversified and regional banks. The Fidelity MSCI Financials Index ETF (FNCL) is the cheapest option with an expense ratio of just 8 basis points. The iShares U.S. Financials ETF (IYF) is another broad financial sector possibility.

Investors looking for more of a pure banking play will want to consider the SPDR S&P Bank ETF (KBE), a fund which has over 85% of the fund dedicated to banks but also has a smattering of asset management firms, mortgage finance companies and diversified financial services businesses mixed in. The SPDR S&P Regional Banking ETF (KRE) is completely invested in regional banking names, but omits the big banks.

Thanks to the financial crisis, there are virtually no banking names that meet the strict dividend aristocrat criteria, but the sector is looking more intriguing now as a dividend growth play than at any time over the past decade. Pairing a dividend aristocrat portfolio with a bank ETF could be a profitable combination for income seekers.

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