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A New Dividend ETF Comes to Town

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

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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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