It’s More About Strategy than Yield #NewsETFs

When an exchange-traded fund (ETF) puts the words dividend and yield into its name, it is looking to attract a certain type of investor. However, just because an ETF name includes those words does not mean that it is a good yield investment. This is the skepticism that investors need to have when they research Vanguard High Dividend Yield ETF (NYSEMKT: VYM). Here’s why some dividend investors might not like what they get with this ETF.

Vanguard High Dividend Yield ETF’s dividend yield is roughly 2.8%. That’s actually a fairly large yield compared to the S&P 500 index, which is only offering a yield of around 1.2%. So, at least in one way, Vanguard High Dividend Yield ETF does live up to its name.

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The problem for investors is that there are other dividend-focused exchange-traded funds with even higher yields. For example, Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is offering a yield of 3.4%. And SPDR Portfolio S&P 500 High Dividend ETF (NYSEMKT: SPYD) has a yield of 4.1%. By comparison, these two ETFs make Vanguard High Dividend Yield ETF look like an income laggard.

The difference is in the way these index-based ETFs create their portfolios. Which, in the end, is the single most important thing an investor should understand when examining an index-driven ETF. You are basically buying the methodology. The ETF’s performance is just a byproduct of the approach it takes. So what is Vanguard High Dividend Yield ETF doing that leads to a yield that is above the market but below that of other dividend-focused ETFs?

The first thing that Vanguard High Dividend Yield ETF does is create an investable universe, which is composed of all dividend-paying U.S. stocks. It then removed real estate investment trusts (REITs). The remaining stocks are lined up from highest yielding to lowest yielding. The highest-yielding 50% of the list gets into the ETF’s portfolio.

At first glance, this clearly suggests that Vanguard High Dividend Yield ETF is focused squarely on owning high-yield stocks, which it is. The problem comes in when you consider the pool from which Vanguard High Dividend Yield ETF is selecting — all U.S. stocks. That’s a huge list that isn’t parsed in any way. So long as a company pays a dividend and has a yield, of any size, it can make it into Vanguard High Dividend Yield ETF. There are over 500 stocks in the portfolio!

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