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According to net inflows of $17.0 billion over the previous three months and $44.5 billion over the previous twelve months as of 4/29/22, dividend ETFs appear to be becoming more popular. While equities ETFs as a whole saw net withdrawals of $5.9 billion in April, dividend ETFs reported net inflows of $7.8 billion1. The great relative performance many of these ETFs have delivered this year can be partially blamed for the rise in demand for dividend ETFs. For those investors looking for exposure to higher quality stocks, additional sources of income, and future dividend increases, we anticipate strong demand to continue. 

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Dividend Sustainability – Winning by Not Losing

First Trust Value Line® Dividend Index Fund (FVD)

We think strategies for sustaining dividends should favour high-quality businesses engaged in comparatively mature or stable markets. These businesses might be able to avoid the dreaded dividend cut and significant downside risk that frequently follows at different points in an economic cycle.

An ETF that seeks dividend-paying stocks with robust balance sheets, generally stable prices, and above average dividend yields is the First Trust Value Line® Dividend Index Fund (FVD). The first step in this approach is to find US-listed stocks that are rated 1 or 2 (out of 5) for “Safety” using Value Line’s® research. The price volatility of a stock over the last five years and an evaluation of its financial strength are used to calculate safety rankings. Several quantitative variables, including debt-to-capital ratios, cash on hand, the volume and consistency of sales and earnings, and returns on capital, are used to evaluate the latter. Additionally taken into account are the sector in which a company works as well as its standing and performance within that sector. This meticulous analysis of a company’s fundamentals aims to help investors avoid securities whose payouts first seem alluring but are more likely to be reduced. The approach then chooses firms from this screened universe that have a market capitalization of at least $1 billion and an implied dividend yield that is higher than the S&P 500 Index. The selection procedure is repeated every month, and the portfolio is equally weighted to remove the risk associated with a single stock.

High Dividend Yield – An Additional Source of Income

First Trust Morningstar Dividend Leaders Index Fund (FDL)

High dividend-yielding stock-focused strategies have been available for a while and have frequently attracted investors looking to increase their investment income. A high dividend yield suggests a stock’s price is low in relation to its dividend by definition. This may represent a belief that dividend reductions are imminent in some cases. So, for high dividend yield ETFs, we think dividend sustainability is essential.

The Morningstar Dividend Leaders Index Fund (FDL), an ETF, chooses 100 of the Morningstar US Market IndexSM’s highest dividend-paying equities, omitting any securities making dividend payments that do not qualify as qualifying income (e.g., real estate investment trusts). A stock’s expected earnings per share must surpass its stated dividend per share in order for it to be included in the strategy, and it also must have lowered dividend payments in the previous five years. We think that this offers the possibility of future dividend payments fundamental support. The weight of the portfolio is determined by the sum of the indicated dividend payments made by each of its members. To increase portfolio diversification, the weighting of each asset is restricted. The index is periodically rebalanced and rebuilt.

Dividend Growth – Keeping Up with Inflation

First Trust Rising Dividend Achievers ETF (RDVY)

Investors worried that excessive inflation may devalue their investment income may find dividend growth techniques to be intriguing. As a result, such strategies tend to place more emphasis on total return and dividend payers who may be in a good position to increase dividends in the future rather than the stocks with the greatest dividend yields currently.

The 50 American stocks that are chosen for inclusion in the First Trust Rising Dividend Achievers ETF (RDVY) have qualities that favour dividend growth. Potential investments must have a track record of increasing dividends supported by earnings growth over the previous three and five years (over the prior three years). Dividend payout rates must be lower than 65% in order to support businesses that reinvest profits to fuel future growth. For dividend programmes to be safe, cash to debt ratios must be higher than 50%. Finally, 50 stocks are chosen, with a maximum of 30% coming from any one sector, that have the most desirable mix of dividend growth, dividend yield, and payout ratio. The initial weighting of the stocks and the effective dates of each rebalance are both equal.

Dividends Plus – Monetizing Volatility with Covered Calls

FT Cboe Vest S&P 500® Dividend Aristocrats Target Income ETF® (KNG)

Investors looking for a higher level of income can also be drawn to dividend ETFs that boost dividends through the use of covered call techniques. Selling call options on the underlying portfolio holdings is a method used in such schemes to earn extra income. Generally speaking, during times of increasing market volatility, option premiums are higher.

The annual selection method for the FT Cboe Vest S&P 500® Dividend Aristocrats Target Income ETF® (KNG) is rather straightforward. Stocks from the S&P 500 Index that have increased dividends for at least 25 consecutive years and meet specific market capitalization and liquidity standards are included in the portfolio. There were just 64 stocks that had achieved this unique achievement as of 4/29/22. This ETF generates income in addition to dividends by selling covered calls on a portion of its portfolio, aiming for a distribution rate that is about 3% greater than the dividend yield of the S&P 500 Index (before fees). Even while KNG is permitted to write calls on up to 20% of the notional value of each of its individual holdings, its income goal can typically be met with a substantially lower overwritten proportion. This is crucial because shares for which a covered call has been written have a performance cap. KNG’s option override percentage as of 3/31/22 was only 5.37%, which meant that 94.63% of the portfolio had no restrictions on upside participation.

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Sector Allocations for Dividend ETFs

Dividend ETFs offer a variety of sector exposures depending on their underlying strategy (see Chart 2). For instance, because FVD places a premium on high quality and low volatility, dividend payers from the industrials (17.9%) and utilities (18.7%) sectors are overrepresented in its portfolio. FDL’s main sector exposures are to the consumer staples (18.3%) and health care (21.9%) sectors because to its focus on high dividend yield. The financials (35.2%) and information technology (25.6%) sectors receive the most allocation from RDVY, which invests in firms thought to have promising future prospects for dividend growth. Finally, KNG invests to mature businesses across a range of industries by focusing on equities with a long history of increasing dividends, with its highest allocations going to the consumer staples (22.7%), industrials (16.9%), materials (12.7%), and health care sectors (11.3%)

Dividend ETFs have received fresh attention this year, and we think the trend will continue. There are many different ETFs available, therefore there are no “one size fits all” options. Instead, various dividend ETFs may aid investors in achieving a range of goals, including increasing exposure to higher-quality equities, finding alternate sources of income, or maybe increasing dividends. As always, we think that selecting which ETFs best suit investors’ needs is something that investment professionals should be heavily involved in.

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Disclaimer:

The performance information is historical. Current performance may be higher or lower than the performance indicated, and past performance is not a guarantee of future outcomes. 

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