A Dividend ETF That Merits a Look

If you have done any research on exchange-traded funds in the last few months, you've probably glanced at more than a few so-called dividend ETFs, that is, funds designed to one way or another have a higher yield than that of the broad market.

Some of my past articles have likely contributed to the glut of dividend ETF information out there, but there is one fund I know about that gets almost no notice, no news coverage and virtually no volume: the First Trust Morningstar Dividend Leaders Index Fund (FDL Quote).

This fund could be poised for good growth over the next year, especially because of its unique weighting toward mega-cap stocks, and I believe it deserves attention.

The ETF's prospectus states that its stock-selection process is proprietary, but that for a stock to be considered, it must pay dividends that are qualified for the 15% tax rate, have five years of dividend growth "greater than or equal to zero" and have a coverage ratio greater than 1. From there, the description gets even more opaque.

Unlike most dividend ETFs, FDL makes some relatively large bets on a few stocks. Bank of America (BAC Quote) is the largest holding, at 9.79%, followed by Citigroup (C Quote) at 9.36% and Pfizer at (PFE Quote) at 9.07%.

There are six stocks each with greater than 5% weight in the fund, and the top 10 stocks comprise 65% of the ETF. The other 90 holdings are spread across the remaining 35% of the fund.

Like all dividend ETFs, FDL is heaviest in financials, at 36.73%, and utilities, which make up 13.15% of holdings. Unlike most other dividend ETFs, though, FDL is heavy in telecom and health care, which come in at 16.94% and 16.74%, respectively.

As the chart below shows, FDL has soundly outperformed both the PowerShares High Yield Equity Dividend Achievers Portfolio (PEY Quote) and the iShares DJ Select Dividend Index Fund (DVY Quote) for the last six months, which is the period of time FDL has been trading.

First Trust Morningstar Dividend Leaders Index Fund Makes some relatively large bets on a few stocks

Source: BigCharts.com

I believe a big chunk of FDL's lead can be attributed to its weight in telecom. That sector, as measured by the Vanguard Telecom Index (VOX Quote), has outperformed DVY by six percentage points over the last six months, the percentage by which FDL has outperformed DVY over the same period. Using VOX as a proxy, FDL may have picked up as much as 1.3% in outperformance by being so heavily weighted toward telecom. Its Pfizer stake, which is up 10% in the last six months, also has helped.

If dividend is important to you, you should know that FDL yields 3.57%, compared to DVY's 3.40% and PEY's 4.27%.

As I mentioned above, FDL distinguishes itself through its weighting in mega-cap stocks, or shares in companies with market caps greater than $100 billion. The ETF has 50% of its assets in mega-caps, compared to DVY's mega-cap weighting of 15.5% and PEY's 8.5%.

I believe that this mega-cap approach, while normally a potential hindrance, could be an advantage over the next year or so. Typically, mega-caps provide leadership toward the end of the stock market cycle, and with the current bull market having enjoyed a 3 1/2-year run so far, it makes sense to think about this cycle ending.

At other points in the market cycle, leadership would probably rotate to dividend ETFs concentrating on smaller companies, which brings up a great closing point: ETFs, including dividend ETFs, are not necessarily "set and forget" investment vehicles. All dividend ETFs have unique structural differences, and knowing how they are affected by the market's swings can benefit your portfolio's bottom line.