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A New Dividend ETF Comes to Town


The big three dividend exchange traded funds better pay attention, because this new competitor is looking very impressive.

Schwab's new dividend fund, Schwab US Dividend Equity ETF (NYSEARCA:SCHD), is the most serious competitor to the big three incumbent dividend funds, Vanguard Dividend Appreciation (NYSEARCA:VIG), iShares Dow Jones Select Dividend (NYSEARCA:DVY), and SPDR S&P Dividend (NYSEARCA:SDY).

The upstart's levy is a mere 0.07% per annum, making the multi-billion-dollar DVY and SDY's fees look embarrassingly avaricious. Even at-cost Vanguard's VIG can't compete when Schwab is pricing SCHD as a loss leader for its higher-margin products.

The bargain-basement pricing doesn't mean you're getting a bargain-basement product. SCHD's strategy is well constructed, striking a nice balance of yield, market representation, and quality.

DVY and SDY may have high yields, but are heavy in smaller, more-distressed stocks. SCHD achieves quality by requiring stocks have paid dividends for a minimum of ten consecutive years, and ranking stocks by a composite score of cash flow to total debt, return on equity, divi-dend yield, and five-year dividend growth rate.

It achieves representativeness by market-weighting its holdings while capping sector- and stock-level expo-sures at 25% and 4.5%, respectively, so distressed mid-cap firms don't dominate its portfolio. Finally, it achieves yield by owning the highest-yielding of the stocks that pass its quality screens.

The resulting portfolio is high-yield quality. According to Dow Jones, the index's dividend yield is 3.2% as of the end of September. In contrast, our perennial favorite VIG's yield is only about 2%.

Time to ditch VIG? Absolutely not. They complement each other beautifully. SCHD is a value fund; VIG is a blend fund, shading toward growth. Both are top-heavy, with about 40% weightings in their top ten holdings, but they only share about half of their top ten names in common.

While each fund alone is good enough for a core holding, together they're even better.

Morningstar's Thesis

Despite its short history, the fund's growth has been astonishing. More than 60% of the fund's holdings carry a wide-moat rating, which suggests they have greater capacity than do their peers to increase their dividend payouts in the future.

For example, holdings such as Chevron (NYSE:CVX), Wal-Mart (NYSE:WMT), and PepsiCo (NYSE:PEP) have consistently raised their dividends and are well-positioned to sustain that growth.

This quality tilt can dampen volatility during market down-turns, but might also cause it to lag in bull markets when investors pile into riskier assets. There is some evidence that the market does not fully appreciate the long-term sustainability and predictability of high-quality firms' earnings more than a few years into the future.
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No positions in stocks mentioned.
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