The day for quality dividend funds in the sun

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A fundamentally weighted equity index fund has constituents chosen based on parameters such as revenue, dividend rates, earnings or book value. One school of thought is that these strategies have the potential to significantly outperform broader markets in inflationary, rising rate economic environments and in bear markets such as those we experience today. To that end, Jeff Weniger, head of equity strategy at WisdomTree Asset Management, explains why the WisdomTree US Quality Dividend Growth Fund (DGRW) could be a compelling proposition for investors.

WisdomTree is a leader in dividend investing strategies. The company launched its first 20 dividend-weighted strategies in June 2006, its first earnings-weighted strategies in February 2007 and its quality dividend growth strategies in 2013. Over the past 16 years, WisdomTree has built a strong reputation and became an $80 billion global asset manager.

DGRW, an exchange-traded fund (ETF) that seeks to track the WisdomTree US Quality Dividend Growth Index, now has approximately $6.1 billion in assets under management.

Individual constituents of market-cap-weighted index ETFs are included in amounts that correspond to their total market capitalization, and constituents of the fund with higher market capitalization receive a higher weight in the fund. Proportionally, the performance of companies with small market capitalizations will have less impact on the performance of the fund as a whole.

In contrast, a dividend-weighted ETF like DGRW reflects the proportionate share of total cash dividends each component company is expected to pay out over the coming year, based on the most recently declared dividend per share. When the fund is rebalanced, companies that have increased their dividends receive a higher weighting.

“DGRW will naturally start to avoid problem stocks and tilt the fund toward quality companies,” he says. “You get natural exposure to balance sheet strength because the type of company that pays a dividend tends to be a more established company.”

Since DGRW filters out companies that don’t pay dividends, it excludes notable growth stocks in the technology sector, including Tesla (TSLA), Meta Platforms (META – formerly Facebook), Amazon (AMZN) and Alphabet (GOOGL). **Nvidia (NVDA) pays a small dividend, so it is underweight in the fund. Admittedly, this hurt the strategy during the last bull market, but now that the economy has changed, DGRW is seeing its day in the sun.

“These winners and the popularity contest stocks now seem to have been given up hard,” says Weniger. “The market seems
buy proven, more conservative trading models, and you get a lot of potential performance.

To be eligible for inclusion in DGRW, companies must be listed on a US stock exchange and be incorporated and headquartered in the United States. They must pay regular cash dividends on shares of their common stock during the 12 months preceding the annual replenishment, which takes place in December. Companies must have a market capitalization of at least $100 million as of the selection date. In addition, the shares must have had an average daily dollar volume of at least $100,000 during the three months preceding the
screening date.

It is important to note that DGRW does not only include high dividend stocks, as a company could pay a high dividend for a reason:
Chapter 11 bankruptcy could be just around the corner, for example. All of WisdomTree’s dividend mandates have a composite risk score based on 16 years of data generated across various economic cycles and significant market events. The fund seeks to weed out risky companies using metrics such as return on equity, return on assets and even momentum. Payout ratios are also a factor: to be included in the DGRW, companies must prove that their profits are greater than the dividend.

Almost all constituents of the fund are large cap companies. Its main holdings** are Johnson & Johnson (JNJ), Apple (AAPL), Microsoft
(MSFT), Philip Morris (PM), Merck (MRK), Coca-Cola (COKE), Proctor & Gamble (PG), Altria (MO), PepsiCo (PEP) and UnitedHealth Group (UNH). However, it also includes mid and small cap stocks.

“At DGRW, dividends tend to parallel value mandates,” Weniger says. “You have these flavors of growth inside the fund, and
then you have those valuable flavors. When you mash these two together, you end up with a mixed investment style.

The fund contains companies from all sectors, but the allocation is different from ETFs that track large-cap index funds such as the S&P 500. For example, as of May 31, consumer staples companies accounted for 6.8% of the S&P 500, while companies in this sector represent 20.6% of DGRW. The fund is overweight consumer staples as these stocks typically play a key role in defensive strategies. DGRW is underweight in the technology sector, although the quality screen picks up profitable and established companies such as Cisco and Intel. This is to weight the market or slightly underweight the consumer discretionary sector and underweight the communication services sector, which is vulnerable to reductions in advertising budgets in inflationary environments.

“Market cap weighting worked great when the S&P 500 was bottoming from March 2009 to the end of 2021, but now the environment has changed,” Weniger concludes. “DGRW uses a transparent weighting formula to amplify the effect that dividends have on the total return of indices. It’s a great way to get wide exposure without blindly buying everything.


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