SDY: The Highest Yielding Dividend Aristocrats In One Terrific ETF

Investors often target dividend aristocrat stocks as a means of generating income from the equity portion of their portfolios. These are the companies that have consistently grown their dividends for many years (20-25 years is the generally accepted requirement) and typically have strong balance sheets, significant cash flows and the ability to continue paying their dividend well into the future.

If there’s one drawback to investing in dividend aristocrats it’s that as a whole they typically don’t provide much of a yield advantage compared to the broader market. That’s why I’m a big fan of the SPDR S&P Dividend ETF (SDY). It provides the strength of investing in dividend aristocrats while offering investors an above average dividend yield.

The S&P Dividend ETF starts by using the S&P 1500 Composite as its base index. This is a nice advantage for the fund since it looks for aristocrats across the total stock market. The fund has about half of its assets in large-caps with another third in mid-caps and the remainder in small-caps. Two other popular ETFs in this area, the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) and the Vanguard Dividend Appreciation ETF (VIG), typically skew towards the large-cap space with around 80% of fund assets in this area.

Within the S&P 1500 Composite, the fund looks for companies that have increased their dividends every year for at least 20 years and weights them according to their dividend yield. It applies liquidity and market cap screens and limits individual holdings to no more than a 4% weighting. What’s left is a portfolio of just over 110 dividend aristocrat names in which the higher yields get a heavier allocation.

As mentioned above, many of the dividend aristocrat ETFs don’t pay a dividend that’s significantly higher than the market. The S&P 500 currently yields around 1.9%. NOBL and VIG don’t do much better with both sporting yields of around 2% even. The S&P Dividend ETF yields over 2.5% with many of the other funds in this category much lower.

The closest comparable to this fund is the PowerShares High Yield Dividend Achievers ETF (PEY). Like the S&P Dividend ETF, this fund focuses on the broader stock market universe by using the largest 1000 companies from the Nasdaq US Benchmark Index as its base. Therefore, it has a nice mix of large-, mid- and small-caps as well. There are a few reasons, though, why I prefer the S&P Dividend ETF in this case.

The primary difference is diversification. The S&P Dividend ETF has over 110 names in the portfolio compared to just 50 in PEY’s portfolio. Further, the S&P Dividend ETF has six sectors receiving allocations of between 10% and 15% making it much more balanced overall vs. PEY which is heavily weighted in utilities and consumer companies. It also wins with a lower expense ratio (0.35% vs. 0.54%) and is about 10-20% less risky looking at the historical standard deviation of daily returns.

The dividend aristocrat strategy has historically worked very well for investors over the long term and this fund is no exception. Over the past 10 years, the S&P High Yield Dividend Aristocrats Index has outperformed the S&P 1500 by nearly 70 basis points annually and has topped the S&P 500 by even more.

As the Treasury yield curve remains low and flat, investors may once again consider returning to equities for higher yields. Some will target high yield ETFs while others will lean towards dividend strength. The S&P Dividend ETF gives you the best of both worlds.

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