Wednesday, November 01, 2006

Exchange Traded Funds with a Dividend Focus

Exchange traded funds (ETFs) are funds that trade like individual stocks. The investment objective of ETFs is to replicate the performance of a particular index. The index upon which an ETF is based can represent a common market index like the S&P 500 Index, a small company stock index like the Russell 2000 index, or the index can represent a segment of the market. For example, ETFs are available to investors that represent specific sectors of the stock market, for example, the financial sector within the S&P 500 index or the financial sector of the Dow Jones Industrial Average.

ETFs with wide ranging investment objectives have been created, in part, due to the popularity of indexing. This popularity has lead to the creation of ETFs with the underlying index based on dividend paying stocks. One drawback of indexing is the performance of the ETF will be in line with the performance of the index in declining markets. In 2000-2002 , investors would have experienced significant declines in the market value of an ETF that replicated the performance of the S&P 500 index during the technology bubble correction. On the other hand, ETFs do trade like stocks so an astute investor could have quickly sold the S&P 500 ETF to minimize potential losses. Often times though, the decision to sell is not evident until one looks back with 20/20 hindsight.

Some of the dividend focused ETFs are:

  • First Trust Morningstar Dividend Leaders Index Fund (ticker FDL)
  • iShares Dow Jones Select Dividend Index (ticker DVY)
  • SPDR Dividend ETF (ticker SDY)
  • Vanguard Dividend Appreciation ETF (ticker VIG)
  • PowerShares High Yield Equity Dividend Achievers Portfolio (ticker PEY)
  • PowerShares Dividend Achievers Portfolio (ticker PFM)
  • PowerShares High Growth Rate Dividend Achievers Portfolio (ticker PHJ)
  • PowerShares International Dividend Achievers Portfolio (ticker PID)
When evaluating ETFs having a narrow investment focus, like those listed above, an investor needs to thoroughly research the composition of the ETF. For example, in the PowerShares High Yield Equity Achievers Portfolio, the financial sector represents over 49% of the investments as of 8/31/2006. In addition to sector concentration, one needs to review the number of stocks within the ETF as well evaluate the percent of the assets invested in the larger holding(s) of the ETF. In the case of the First Trust Morningstar Dividend Leaders Index Fund, Citigroup is over 9% of the investments as of 8/31/2006. Also, over 65% of the Morningstar Dividend Leaders ETF is invested in the top 10 holdings of the ETF as of 8/31/2006.

In conclusion, there are a number of other issues one must evaluate before investing in ETFs: taxes, expense ratio, yield, etc. A positve aspect of ETF type investments is an investor can obtain exposure to certain areas of the market in a quick manner. Keep in mind though, there aren't any famous market timers.

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