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Investment Ideas

In the current environment of ultra-low interest rates, the popularity of high-yield products has exploded. As traditional sources of income currently offer minuscule yields, yield-hungry investors have poured a lot of money into products with high yields like junk bonds, MLPs, mortgage REITs and high dividend stocks.

Many of these higher income products are bundled with higher risk. Junk bonds in particular look extremely risky as of now. (Read: 4 Excellent ETFs for Income and Stability)

Dividends in Focus

Compared to other high yield products, high dividend stocks now appear to be the best bet for yield-starved investors. Many of the U.S. dividend payers are stable, cash-rich companies that are likely to continue to increase their dividends. (Read: 3 Red Hot Dividend ETFs)

According to a NY Times article, dividend payers in the S&P 500 index returned 8.92% on average, compared with 1.83% for non-dividend stocks, with significantly lower volatility, between 1972 and 2011.

Is Low-Volatility the Best Investing Strategy?

Low-volatility investing is no doubt one of the most popular investing themes now-a-days. Our research has shown that low-volatility stocks handily beat the broader markets with significantly lower volatility in the U.S., international markets and emerging markets, over longer periods. (Read: Buy these ETFs for Higher Returns and Lower Risk)

No wonder the flagship product in this space, PowerShares S&P 500 Low Volatility ETF (SPLV - ETF report) has been one of the most successful launches in ETF history and many more products have been launched after SPLV to capitalize on the growing investor appetite for these low-volatility products.

High Dividends and Low-Volatility—the Best of Both Worlds?

Thankfully some new products combine the two most desirable investment themes—high dividend and low volatility.

As the concept is relatively new in the ETF world, very little historical performance data for the ETFs is available. We therefore looked at the five-year risk-return performance of the S&P 500 Low Volatility High Dividend index and compared its performance with the broader market S&P 500 index (using monthly returns data for the two indexes for the period 3/31/2008--2/28/2013).

Over the last five years, the S&P 500 Low-Volatility High-Dividend index substantially outperformed the S&P 500 index, with lower volatility while at the same time providing a high level of dividend yield to the investors. 

Index (ETF)

Annualized Return     (5 Y)

Annualized Std.Dev. (5 Y)

S&P 500 Low Volatility High Dividend Index TR (SPHD - ETF report)

13.92%

17.29%

S&P 500 TR Index (SPY)

6.82%

19.03%

PowerShares S&P 500 High Dividend Low Volatility Portfolio (SPHD - ETF report)

The index is composed of 50 stocks that historically have provided high dividend yields and exhibited low volatility. First, 75 stocks in the S&P 500 index with the highest 12-month dividend yield are chosen, with not more than 10 in any single sector.

Then, from the 75, the 50 stocks with lowest realized volatility over the last 252 trading days are selected. Index constituents are weighted by the dividend yield but each index constituent is constrained between 0.05% and 3.0%, while the weight of each sector is capped at 25%. The index is rebalanced semiannually.

The ETF is heavily weighted towards Utilities (24%), Financials (16%) and Consumer Staples (13%) sectors. The fund has returned 10.02% year-to-date, a little higher than 9.42% for SPY--the ETF tracking the broader market.

Launched in October last year, the fund has already attracted about $79 million in assets.It charges an expense ratio of 30 basis points and currently has an excellent distribution yield of 3.45% and a 30-day SEC yield of 3.80%, compared with 1.92% for SPY.

Global X SuperDividend U.S. ETF (DIV - ETF report)

Launched earlier this month, this ETF tracks the INDXX SuperDividend U.S. Low Volatility Index that holds 50 of highest yielding U.S. stocks, MLPs and REITs, in equal weights.

In order to be included in the index, the constituents should have a minimum market cap of $500 million, meet certain liquidity criteria and should have paid dividends consistently for the last two years. Sector weights are capped at 25% while the cap for MLPs is 20% of the index. Further companies should have a beta of less than 0.85 relative to the S&P 500 to be eligible for inclusion in the Index.

The index is rebalanced annually but the index components are screened every quarter for dividend cuts or any negative outlook concerning the companies’ dividend policy.

 The fund is currently heavily weighted towards REITs (24%) and Utilities (24%) while MLPs (18%) round out the top three.

This ETF is slightly more expensive, charging the investors 45 basis points annually compared with just 30 basis points charged by SPHD.

The Bottom Line

By investing in low-volatility, high-dividend ETFs, income oriented investors can enjoy higher yields and higher longer-term returns with lower risk; however, they should be prepared for shorter-term underperformance during strong bull markets.

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