The results are similar for the SPDR S&P Dividend ETF (SDY), which — like VIG — tracks an index that uses past dividend growth as a criterion for the construction. Since May 2006, the fund has returned 6.62%. Much of the shortfall relative to VIG is accounted for by expenses, as SDY charges 0.35% versus VIG’s 0.10%.
Investors also can choose WisdomTree U.S. Dividend Growth Fund (DGRW), which focuses on the potential for dividend growth in the future rather than building its portfolio on the basis of past dividend growth. The fund just opened in May, however, so the strategy still needs time to prove itself.
Dividend Growers Often More than Just Higher Returns
The superior performance record isn’t the only benefit of focusing on dividend growth over yield. Funds with an absolute-yield tilt tend to have greater sector concentration than those invested in dividend growers. DVY, for instance, holds a weighting of nearly 30% in utilities and another 33.8% in industrials and consumer goods. In contrast, VIG — while certainly more concentrated than a broad-based index fund such as the SPDR S&P 500 ETF (SPY) — offers a much broader portfolio.
The concentration of absolute-yield funds makes them more vulnerable to rising interest rates. During the selloff in income-generating assets that ran from May 22 through June 24, DVY shed 5% and slightly underperformed the broader market. This is a very small sample, but it hints at the potential impact that a rising-rate environment could have on the highest-yielding stocks.
Finally, the timing could be right for a focus on dividend growers to pay off. In its July 26 research note, Bank of America Merrill Lynch notes that dividend growth stocks are near their cheapest valuation relative to high-dividend yield stocks in the past 23 years. Among the individual dividend growers to which it has awarded “buy” ratings are Cisco (CSCO), Microsoft (MSFT), General Electric (GE) and Pfizer (PFE).
The Bottom Line
Dividend stocks remain in high demand, and with good reason. But investors who are looking to generate the biggest bang for their buck over the long-term would be well-served by honing their focus on dividend growth over absolute yield.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.