DVY ETF: Higher Income, Less Volatility

Dividend investors have a lot of options to choose from these days, despite the recent market rally. However, there are some investors that would simply rather spend their time on other things than trying their hand at stock picking.

That’s why diversified ETFs may be a better option for this segment of investors, and this brings me to the iShares Select Dividend ETF (NASDAQ:DVY). Even after the recent slight rally in price, DVY is still well-off from where it was a year ago, with a 9% price decline over the past 12 months, resulting in a 3.8% dividend yield.

In this article, I discuss the merits of investing in DVY and why income investors may want to consider layering into the ETF at present, so let’s get started!

Why DVY?

DVY is a diversified dividend ETF that’s invests in large-cap U.S. companies with a consistent history of dividends of at least 5 years. At present, it carries 99 holdings (target objective is 100) and has a good mix of investment sectors. This includes the more asset-heavy but stable revenue utilities segment, the asset-light financial segment, consumer companies (cyclical and defensive) being its top 3 sectors, comprising 70% of total portfolio value, as shown below.

Investing in a basket of relatively high dividend paying companies has worked out well for DVY and its investors. This is reflected by DVY’s outperformance over the past 3 years with a 33.2% total return, comparing favorably to its peer group, including iShares Core Dividend Growth ETF (DGRO), iShares Core High Dividend ETF (HDV), and SPDR S&P Dividend ETF (SDY). Just for kicks, I’ve also included the S&P 500 (SPY), which has also underperformed DVY over the past 3-year period, as shown below.

It’s not unsurprising, however, that DVY has underperformed the S&P 500 and some of its growth-oriented peers over the long-term, due to its focus on high current yield that’s generally tilted towards perpetual value stocks. As shown below, DVY has given a 128% total return over the past 10 years, sitting below the 202% return of the S&P 500 over the same timeframe.

While DVY may not have given an eye popping total return over the past decade, total returns are not the point for this ETF, as investors should be more interested in the dividend. With a 3.8% TTM dividend yield, this sits above the 2.5% median yield across all ETFs. Moreover, DVY has a 10 year dividend CAGR of 7.1%, which combined with the 3.8% starting yield could result in a long term 11% annual total return. As shown below, DVY’s current yield and dividend growth compares favorably to that of its peer group.

Moreover, those holding onto DVY may experience less price volatility compared to the overall market. This is reflected by DVY’s 3-year equity Beta of 0.82, sitting 18 basis points below the 1.0 market average. This shouldn’t come as much of a surprise considering DVY’s top holdings which as shown below include high yielding names with long dividend track records, like Altria (MO), Verizon (VZ), IBM (IBM), and ONEOK (OKE), with yields ranging from 4% to 9%.

Potential catalysts for DVY include the relative undervaluation for its holdings compared to the broader, new tech-driven market average. This is reflected by names like Altria and Verizon that are currently trading well below their historic average valuations, all while pumping out reliable income for their investors.

Risks, however, include potential for a market pullback after the November rally, especially if the Federal Reserve resumes a hawkish stance toward interest rates. Higher interest rates can negatively impact dividend stocks in particular, due to investors’ perceived opportunity cost around investing in risk-based assets such as dividend-paying equities versus risk-free treasury bonds.

Higher interest rates also raise the cost of debt funding for utility companies in DVY’s portfolio and could result in a recession, which could negatively impact DVY’s financial and consumer stocks. These risks are worth bearing in mind.

Nonetheless, recessions come and go, and given that equities remain a good inflation hedge due to the underlying pricing power of moat-worthy companies in DVY’s portfolio, long-term investors may do well to layer in to DVY at present.

Investor Takeaway

A multitude of dividend opportunities are available for investors, but diversified ETFs such as DVY may be a better option for those who prefer not to pick individual stocks. With its long-standing track record of solid performance and strong current yield, DVY could provide income investors with a reliable income stream while also providing some relative price stability in their portfolio.

While there are risks to consider, the potential for undervalued holdings and a diversified portfolio make DVY worth considering for investors to add an income kicker to their portfolios. As such, investors may want to consider layering into DVY at its current price for potentially strong and less volatile total returns and income.