When it comes to income-based investments, choices are limited, as current prevailing interest rates are at historic lows. Japan and Germany are in negative yields on their sovereign debt, and U.S. 10-year Treasuries are in the 1.3% territory. These unprecedented circumstances leave most income-focused investors scrambling for alternatives. Corporate bonds and junk bonds have seen an enormous increase in demand, despite commensurate expanded risk. Preferred and dividend-paying stocks have also gained popularity, as dividend yields outpace those of bonds.
Mutual funds and ETFs categorized in the growth and income sectors accumulate portfolios of dividend-paying stocks in order to capture the upside market appreciation for the growth portion while collecting dividends to supply their shareholders with the income component. A majority of managers of these blended funds use historical dividend statistics to analyze and determine their selections. The focus is on steady and uninterrupted quarterly dividends. This retrospective approach, however, has its downsides, as evidenced by funds that held General Motors (NYSE: GM) stock before the government bailout.
WisdomTree U.S. Quality Dividend Growth Fund (DGRW) is an ETF that is somewhat contrarian in this regard in that it selects holdings based on anticipated dividend increases in order to meet its targets for yield. While it may seem counterintuitive, DGRW seeks companies in sectors where strong growth prospects are expected to outstrip their expansion needs, with the rationale that the odds of potential dividend increases are inherently better when there is more potential for growth.
DGRW’s stock selection analysis is predicated on the WisdomTree U.S. Quality Dividend Growth Index (WTDGI), a list of 300 stocks that analyzes companies and weights with a bias toward those sectors with both strong market cap and dividend growth, such as the information technology arena. The dividend coverage ratio must exceed 1.0, and the market cap for any company under consideration for inclusion must be a minimum of $2 billion.
Investment Strategy
DGRW is managed by WisdomTree’s Jeremy Schwartz, director of research, and one of his primary analytical strategies utilizes the WTDGI to calculate return on assets (ROA) and return on equity (ROE) as the prime criteria for assessing forward-seeking dividend growth. This process helps eliminate from consideration those companies whose financial leverage status can lead to potential dividend reductions. The inclusion of ROA disqualifies companies whose ROE may be artificially inflated through debt finance. However, ROA and ROE are not infallible predictors of dividend payout policies, in spite of the companies’ demonstrated stronger financial capacity to do so.
The DGRW analysis protocol also includes a sizable number of companies that are eager to enact buybacks of their common shares. Roughly 40 percent of the DGRW portfolio is allocated to the technology and consumer discretionary sectors, both of which have been the historical share repurchasing leaders over the past few years. This is a notable departure from rival ETFs and has been a significant contributing factor to dividend payout growth. The strategic advantage to this approach is that DGRW holdings are overweight with stocks whose prices are a relative bargain as compared with their peers, when based on dividends. The approach also triggers sell targets when the stocks become expensive relative to their peers. Fund strategy policy dictates that no single stock can constitute over 5 percent of the index, and no sector can make up more than 20 percent of the index. There is an annual index rebalance. Morningstar suggests that DGRW has a larger cushion to protect dividend payments in the event that earnings unexpectedly dry up.
Fund Details and Performance
WisdomTree U.S. Quality Dividend Growth Fund has total assets of $635.8 million. Founded in 2013, it has a year-to-date return of 5.11 percent and a 3-year average return of 11.5 percent. Classified as a Large Blend fund, it has an average daily volume of 94,000 shares. The current yield is 2.13 percent, with a distribution yield of 2.24 percent.
Portfolio Composition
With 100 percent of the portfolio invested in growth-oriented, dividend-paying stocks, DGRW is devoid of traditional dividend plays such as utilities or energy stocks, which account for less than 1 percent of holdings. Industrials presently account for 20.42 percent, consumer discretionary 19.75 percent, information technology 19.21 percent and consumer staples 18.51 percent. Financial services at 3.3 percent, basic materials at 2.96 percent, communications services at 1.6 percent and real estate at a scant 0.1 percent round out the remainder. The relatively small real estate and banking stock positions are due to comparatively high financial leverage in those sectors, which impacts ROA.
The top 10 holdings within the portfolio are Coca-Cola, Altria Group, Microsoft, AbbVie, Apple, IBM, McDonald’s, Cisco Systems, 3M and Intel.
DGRW is a solid dividend growth fund that can serve as a core portfolio holding. The fund offers investors payout growth opportunity, but it comes with increased volatility relative to other dividend funds due to its sector weightings. Additionally, it is slightly more volatile than the S&P 500 Index, which is surprising for a dividend-focused ETF.
In sum, investors with longer timelines and a slightly more aggressive outlook may prefer DGRW. For investors requiring current high income, other funds such as Vanguard High Dividend Yield (VYM) or iShares Core High Dividend (HDV) may be more appropriate. Currently, we have recommended DGRW as a Strong Buy with a ranking of 86.