In the smart beta space, a variety of strategies have proven successful and issuers of exchange traded funds (ETFs) are testing the waters with new weighting methodologies. Among the most seasoned and successful funds that are fundamentally-weighted are growth, value and dividend funds.

In fact, all of the 10 largest US-listed smart beta ETFs are either growth, value or dividend funds. Of those 10, four are dividend funds, one of which is the SPDR S&P Dividend ETF (SDY). SDY is not only large, it is seasoned. The dividend ETF recently turned 12 years old and has over $16.6 billion in assets under management, proving investors are fans of dividends in the ETF wrapper.

SDY tracks the S&P High Yield Dividend Aristocrats Index. While the name of that benchmark implies a high yield, SDY's dividend yield is 2.32%, which is not alarmingly high. The S&P High Yield Dividend Aristocrats Index mandates that member firms have dividend increase streaks of at least 20 years, a trait that has made SDY a hit with income investors.

Fortunately, SDY belies the high yield implications of its index's name.

SDY “effectively mitigates some of the risks associated with high-dividend-paying stocks by screening for highly profitable companies with a long track record of increasing dividend payments,” said Morningstar. “This dual focus reduces the fund's exposure to firms with weak fundamentals that may not be able to sustain their dividend payments, which is a risk that often accompanies a narrow focus on yield.”

Due to its emphasis on length of dividend increase streaks, it can be argued some of SDY's 107 holdings meet the criteria of the quality factor. While definitions vary, hallmarks of quality often include strong management teams and solid balance sheets. Additionally, SDY reflects the often less volatile nature of dividend stocks relative to non-dividend payers.

Over the past three years, SDY's standard deviation is slightly higher than the S&P 500's, but the dividend ETF's maximum drawdown over that span is 210 basis points less than the S&P 500's.

SDY's holdings are weighted by yield, giving the ETF's member firms a smaller average market value than rival dividend funds.

“Despite its smaller market capitalization, the fund's tilt toward more-stable stocks has helped it shine during market downturns,” according to Morningstar. “It held up better than the Russell 1000 Value Index and landed in the top quartile of the large-value category during the market drawdown from October 2008 to March 2009. The fund outpaced its category by 3.2% during the trailing 10 years through October 2017, primarily because of greater exposure to utilities stocks, smaller exposure to energy stocks, and more favorable stock exposure within the financial sector.”

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