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These ETFs Get It: Dividend Growth Beats Yield

When income investors look for stocks to invest in, one of the first things most consider is the size of the yield.

But yield should be secondary to a much more important consideration: dividend growth rates.

In fact, some of the best opportunities for dividend investing are companies sporting yields that may seem modest today, but are headed aggressively upwards.

Recently, WisdomTree launched three new funds focusing on just those companies.

Of course, dividend growth isn’t the only metric that needs to be considered, so let’s take a look and see how these funds stack up…

Breaking the High-Yield Mold

Dividend growth rates, despite being widely overlooked by personal investors, are extremely important.

So important, in fact, that shrinking dividends are usually reason enough to dismiss a stock for good. Simply because it usually means there are a host of other problems under the hood.

But while many mutual funds and ETF managers do indeed take dividend growth rates into consideration, it’s not usually the stated or primary focus of those funds.

The reason being that a dividend-oriented fund needs to have competitive current dividend yields to drive up total returns beyond its benchmark index.

And beating the benchmark, of course, attracts investors – and their dollars.

This need for competitive yields as a publicity point means that some lower-yielding stocks – which nonetheless have faster growth rates – get less representation.

These new WisdomTree funds, on the other hand, aim to differentiate themselves from the competition by doing the opposite. That is, showcasing not the highest yielders, but the fastest growers, instead.

Dividends Drive Higher Total Returns

The oldest fund in this trio of new funds isn’t even three months old.

Called the WisdomTree U.S. Dividend Growth Fund (DGRW), it’s benchmarked against a custom index, the WisdomTree U.S. Dividend Growth Index.

The ETF is actively managed and invests in U.S. companies with market capitalizations of at least $2 billion (90% of the portfolio is large cap).

Despite being actively managed, expenses for DGRW are only 0.28%. While this is much higher than the SPDR S&P 500 Index ETF’s (SPY) expenses of .0945%, it’s nevertheless a competitive rate and much lower than that of many other actively managed ETFs.

The other two funds in WisdomTree’s growing suite of dividend growth ETFs are WisdomTree Emerging Markets Dividend Growth Fund (DGRE) and the WisdomTree U.S. SmallCap Dividend Growth Fund (DGRS).

Like DGRW, they track WisdomTree’s own indices and are actively managed.

The question that will be answered over time is whether these new funds will have better total returns than similar funds not specifically targeting companies with higher dividend growth rates.

It’s certainly very likely, especially since dividends are critical to total return.

Case in point: Between 1950 and 2010, the return of the S&P 500 with dividends included is about eight times what it would’ve been based on price change alone.

Still, right now, as far as yield is concerned, there’s only a slight difference between DGRW and SPY. Respectively, their 30-day SEC yields are 1.99% and 1.83%.

The two newer funds (DGRE and DGRS), launched July 25 and August 1, have no yield to report yet.

But given the importance of dividends in total return, over time, one might expect DGRW to outperform SPY, assuming that its average dividend growth rate is superior to the S&P 500’s.

In order to make this happen, the fund’s management team must also, at a minimum, keep pace with the price performance of index-based ETFs like SPY.

Those higher reinvested dividends will compound over time and make a significant impact on total return so long as the growth of the ETF doesn’t lag its competitors.

The same will be true of DGRS versus a small-cap index like the iShares Russell 2000 Index ETF (IWM), which holds a current dividend yield of 1.67%… And DGRE versus an emerging markets index ETF like the iShares MSCI Emerging Markets Index ETF (EEM), whose current yield clocks in at 1.9%.

Bottom line: Based on all the evidence that links dividend growth to total returns, if management does its job correctly, these funds have more than a fighting chance at outperforming index-specific ETFs like SPY, IWM and EEM.

Even more so considering WisdomTree’s past success and commitment to dividends as a focus of nearly all of its ETFs. In the end, investors could do far worse than adding these funds into an income-oriented portfolio.

Safe investing,

Steve Gunn