All eyes are on the Federal Reserve this week with many fixed income traders indicating the first rate hike of 2017 is all but a done deal. Higher interest rates could affect a wide array of income-generating asset classes and sectors, including some dividend exchange traded funds.
Some dividend ETFs feature heavy allocations to higher-yielding sectors, such as consumer staples and utilities. Given the bond-like qualities of those groups, particularly utilities, ETFs with large weights to those sectors can be vulnerable to higher interest rates.
“Since 1953, whenever the yield on the S&P 500 index was within one percentage point of the yield on the 10-year Treasury, as it currently is, the S&P 500 rose in price an average of 11% in the following 12 months, and had positive results 77% of the time, according to Sam Stovall, chief investment strategist at CFRA,” said CFRA Research in a note out Monday.
Home to $17.1 billion in assets under management, the iShares Select Dividend ETF DVY is one of the largest U.S. dividend ETFs. DVY's trailing 12-month yield of 2.92 percent isn't alarmingly high, but the ETF's 28.5 percent weight to utilities stocks, by far its largest sector allocation, could be a cause for concern.
DVY “has shed $302 million in assets to start 2017. DVY focuses on companies with a five-year record of paying dividends and a relatively high yield. Relative to the S&P 500 index, the ETF is significantly overweighted to defensive utilities (28 percent vs. 3 percent),” said CFRA.
The Vanguard High Yield Dividend ETF VYM clearly advertises itself as a high dividend ETF, but a trailing 12-month yield of 2.8 percent might indicate otherwise. Additionally, for a high yield strategy, VYM's utilities weight is relatively low at just 7.8 percent.
VYM “experienced $393 million of net outflows year to date. VYM has a comparable 2.8 percent yield, but the sector exposure is distinct from DVY’s. The overweighting to utilities (8 percent) is more muted, but exposure to AT&T T and other telecom services (5 percent) is higher,” said CFRA.
CFRA has a Market Weight rating on DVY and an Overweight rating on VYM. Over the past three years, DVY is up 40.6 percent, while VYM is higher by 38.9 percent.
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