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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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This inefficiency may arise because many investors have relatively short investment horizons. As a result, there may be an opportunity for long-term investors to profit from the market's myopic focus by holding the type of reasonably priced quality stocks that this fund tracks.
If Congress does not take further action, qualified dividends will lose their preferential tax treatment at the end of this year. Starting January 2013, all dividends will be taxed at ordinary rates.

Consequently, this fund may lose its appeal for investors in higher tax brackets, though it may still be a good option for tax-sheltered accounts. Taxes on long-term capital gains are also slated to increase to 20% from 15%. (This rate will fall to 10% for investors in the 15% tax bracket.)

As a result, dividends will become a less tax-efficient method to return capital to shareholders than share buyback programs. Under this new tax regime, many companies may pursue share buyback programs more aggressively in lieu of raising their cash dividends, which may reduce the dividend yield investors can expect from this fund in the future.

Portfolio Construction

The fund tracks the Dow Jones US Dividend 100 Index, which selects companies with strong fundamentals, high dividend yields, and a long track record of dividend continuity.

This index starts with the largest 2,500 US stocks, excluding REITs, master limited partnerships, preferred stocks, and convertibles. From this list, Dow Jones screens for companies that have made dividend payments for a minimum of ten consecutive years, a market cap of at least $500 million, and a minimum average daily trading volume of $2 million. It then orders the stocks that pass these screens by dividend yield.

The stocks in the top half of this list form the universe of eligible stocks for the index. Dow ranks these stocks on cash flow to total debt, return on equity, dividend yield, and five-year dividend growth rate. Elegantly bringing this information together through an equally weighted composite score, Dow orders the eligible stocks by their composite score and selects the top 100 names for inclusion in the index.

Dow Jones applies a modified cap-weighting approach that limits individual holdings to 4.5% and industry exposure to 25% of the portfolio. The index is reconstituted annually in March and rebalanced quarterly.

In order to keep turnover low, Dow keeps stocks in the index as long as their composite score remains in the top 200 of the eligible universe. This approach not only promotes tax efficiency, but also helps Schwab keep management fees low.

Fees

Schwab recently reduced the fund's expense ratio to a razor-thin 0.07%, making it the cheapest dividend-strategy fund on the market.

Editor's Note: This article was written by Samuel Lee of Morningstar ETFInvestor.

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No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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