{"id":24287,"date":"2011-10-05T10:28:10","date_gmt":"2011-10-05T14:28:10","guid":{"rendered":"http:\/\/countingpips.com\/fx\/2011\/10\/05\/should-you-avoid-financial-stocks-when-searching-for-dividends\/"},"modified":"2011-10-05T10:28:10","modified_gmt":"2011-10-05T14:28:10","slug":"should-you-avoid-financial-stocks-when-searching-for-dividends","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/fx\/2011\/10\/05\/should-you-avoid-financial-stocks-when-searching-for-dividends\/","title":{"rendered":"Should You Avoid Financial Stocks When Searching for Dividends?"},"content":{"rendered":"

By The Sizemore Letter<\/a><\/p>\n

\"\"<\/a>Given the woes plaguing the global banking sector\u2014among them the never-ending Greek drama and a U.S. mortgage market that refuses to improve\u2014it\u2019s not surprising to see investors fleeing financial stocks.\u00a0 The popular Financial Select SPDR (NYSE: $<\/span>XLF<\/a>)<\/strong> is down more than 15% in just the past three months alone.\u00a0 Aggressive traders have started to nibble a little at financial stocks, but most conservative investors are still steering clear.<\/p>\n

This is particularly obvious by the recent popularity of the WisdomTree Dividend ex-Financials ETF ($<\/span>DTN<\/a>)<\/strong>.\u00a0 Forbes reports<\/a> that the ETF has seen inflows in the past week that have expanded its shares outstanding by nearly 4%.<\/p>\n

Dividends are en vogue these days, and with good reason.\u00a0 After a decade in which investors have seen little in the way of capital gains, cash dividends ensure that they see a return that is not entirely dependent on the fickle whims of the market.\u00a0 Moreover, the companies that pay dividends tend to be less volatile than those that do not.\u00a0 And given the paltry yields on offer in the bond market, investors can hardly be blamed for running to high-dividend stocks instead.<\/p>\n

WisdomTree\u2019s explicit focus on the absence of financial stocks in DTN is telling.\u00a0 The 2008 meltdown was first and foremost a banking crisis, as is the festering European sovereign debt crisis.\u00a0 Investors want to know that the dividends they depend on are safe.\u00a0 Virtually all banks slashed their dividends during the 2008 crisis, and investors fear it will happen again.<\/p>\n

Alas, I fear that this is another case of closing the barn door after the horse has already bolted.\u00a0 There is little need for an ex-financials dividend ETF because few dividend-focused ETFs have much exposure to the financial sector today.\u00a0 None of the ETFs based on the Mergent Dividend Achievers Methodology\u2014such as the Vanguard Dividend Appreciation (NYSE: $<\/span>VIG<\/a>)<\/strong> and the PowerShares Dividend Achievers (NYSE: $<\/span>PFM<\/a>)<\/strong>\u2014have much in the way of financial exposure.\u00a0 Considering that a prerequisite for membership is ten consecutive years of rising dividends, none of the banks that slashed their payouts in 2008 or 2009 would make the grade.\u00a0 VIG and PFM have 6 percent and 4 percent of their respective portfolios in financials.<\/p>\n

Similarly, the iShares Dow Jones Select Dividend (NYSE: $<\/span>DVY<\/a>)<\/strong>\u2014the largest and most widely-traded dividend-focused ETF\u2014has only 9 percent of its portfolio in financials.<\/p>\n

It would seem that the ex-financials ETF brings very little new to the table.\u00a0 Still, to give the ex-financials ETF the benefit of the doubt, let\u2019s see how it performed relative to its less restrictive peers during the past three months of intense volatility.\u00a0 Figure 1 compares DTN\u2019s performance against its sister ETF, the WisdomTree Dividend ETF (NYSE: DTD).\u00a0 For all intents and purposes, the index that is used to construct DTN is the index used to construct DTD, minus the financial sector.\u00a0 For good measure, I also included the iShares DVY.<\/p>\n

\n
\"\"<\/a><\/p>\n

Figure 1<\/p>\n<\/div>\n<\/div>\n

The ex-financials ETF has modestly outperformed its broader WisdomTree sister fund, but it traded in virtual lockstep with the iShares DVY.\u00a0 And its outperformance relative to its sister fund is due less to the absence of financials as much as the relative overweighting of defensive sectors like utilities.\u00a0 Utilities make up 18.5 percent of the ex-financials ETF and only 8.7% of the broader ETF.<\/p>\n

Ok, perhaps the past three months isn\u2019t a big enough sample set to judge the value of an investment strategy.\u00a0 Let\u2019s try this exercise again, including the meltdown years of 2008 and 2009.<\/p>\n

\n
\"\"<\/a><\/p>\n

Figure2<\/p>\n<\/div>\n<\/div>\n

Here, the story gets a little more interesting. \u00a0The iShares DVY started to break down earlier due to its larger holdings of financials.\u00a0 Before the crisis, the financial sector was a large component of DVY.\u00a0 But before the dust finally settled in March of 2009, it didn\u2019t matter much.\u00a0 All three funds bottomed out at comparable lows.\u00a0 The two WisdomTree ETFs traded in lockstep during the subsequent \u201cmelt up\u201d from the March 2009 bottom to early 2010 top before the ex-financials began to modestly pull ahead.<\/p>\n

What are we to take away from this?<\/p>\n

I\u2019ll start with a general observation: there are simply too many ETFs out there.\u00a0 I tip my hat to WisdomTree for blazing new trails with fundamental indexing.\u00a0 This was an exciting area of academic finance a few years ago, and they deserve credit for applying it to the real world of investing.\u00a0 But there is no reason to have the Dividend ETF (DTD), the ex-Financials ETF (DTN), and even the Large Cap Dividend ETF (NYSE: $<\/span>DLN<\/a>), which I current use as a proxy for high-quality U.S. equity in the Sizemore Capital Tactical ETF model.\u00a0\u00a0 \u00a0Pick one, guys.\u00a0 They\u2019re not different enough to warrant having all three.\u00a0 I could make similar arguments for PowerShares suite of dividend ETFs, but I\u2019ll spare readers the rant.<\/p>\n

Secondly, when all hell broke loose in 2008, the ex-Financials ETF didn\u2019t do materially better than its peers in protecting investors.\u00a0 Not having exposure to the financial sector mattered surprisingly little.<\/p>\n

And finally, the rationale for an ex-Financials dividend ETF is questionable at best.\u00a0 As I said before, few U.S. financial firms currently meet the criteria to be included in the broader dividend ETFs.\u00a0 Assuming that, with the passage of time, the financial sector warrants membership again, a better approach might be to limit the ETFs allocation to any one sector, financials or otherwise.\u00a0 Good financial stocks should<\/em> be included in an investor\u2019s dividend stock portfolio.<\/p>\n

Now, as to the question of what qualifies as a \u201cgood\u201d financial stock in this environment, that is a different subject for a different article.\u00a0 One thing at a time.<\/p>\n

Disclosure: Sizemore Capital\u00a0Management currently has positions in DLN and DVY in client portfolios.\u00a0<\/p>\n

If you liked this article by Sizemore Insights<\/em>, you\u2019d probably enjoy The Sizemore Investment Letter<\/em>, our premium members-only newsletter. Click here<\/a> for more information.<\/p>\n","protected":false},"excerpt":{"rendered":"

By The Sizemore Letter Given the woes plaguing the global banking sector\u2014among them the never-ending Greek drama and a U.S. mortgage market that refuses to improve\u2014it\u2019s not surprising to see investors fleeing financial stocks.\u00a0 The popular Financial Select SPDR (NYSE: $XLF) is down more than 15% in just the past three months alone.\u00a0 Aggressive traders … <\/p>\n

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