Dividend ETF Off to Rousing Start

NEW YORK ( TheStreet) -- Both the iShares Dow Jones Select Dividend Index Fund ( DVY) and SPDR S&P Dividend ETF ( SDY) appear set to kick off the New Year on a strong note.

In the face of the seemingly persistent doom and gloom that plagued the latter half of 2011, the two funds have managed to handedly outpace broad-based ETFs like the SPDR S&P 500 ETF ( SPY).

The real winner in the realm of dividend ETFs, however, has been the iShares Dow Jones High Yield Equity Fund ( HDV). The new kid on the block, HDV powered past its veteran competitors, securing over 7% gains during the past six-month period. This was not an unusual occurrence for the fund, though.

Since its late-march unveiling, HDV has consistently trumped DVY and SDY. With this type of standout strength, came popularity. The fund's average trading volume currently stands at over 220,000.

HDV appears to have already cemented its place within the ETF universe. Now as we prepare to kick off 2012, the question remains: Will the fund maintain its lead in the New Year?

In order to answer to this question, one needs to look under the fund's hood. By uncovering the factors that separate HDV from its competitors, it becomes easier to see what has, and could continue to contribute to its remarkable divergence.

Upon initial inspection it becomes clear that HDV is very different from the elder DVY. In terms of style, the younger fund leans solidly into the large-cap category. In fact, according to Morningstar's style box, HDV can be seen flirting with a giant-cap designation.

DVY, though officially considered a large cap product, toes the line between a large- and mid-cap classification.

During periods of market euphoria, smaller and more-volatile companies like those comprising DVY tend to fall into favor as increasingly confident investors seek out upside potential.

In tumultuous environments, on the other hand, these same companies often lag as individuals flee from risk. In the event that the turmoil that defined 2011 persists into the New Year, HDV's dedication to stable large- and mega-cap companies will likely help the fund continue to outperform.

Further aiding HDV in 2011 was the fund's ample exposure to defensive sectors. Utilities comprise nearly one-third of DVY's index, making it an attractive play for those looking for protection from market headwinds. In terms of overall safety, however, the fund pales in comparison to HDV. Names hailing from non-cyclicals including utilities, consumer goods, healthcare, and telecommunications dominate the younger fund's index, representing over 80% of its assets.

At the same time that the fund designates the largest percentages of its portfolio to safety, it also shields itself from weakness. Lagging market corners, such as financials and materials, are among the least represented in the fund's breakdown, together accounting for less than 2% of its assets. Comparatively, these two sectors make up more than 20% of DVY's index.

As we prepare to close the book on 2011 and look to the opening weeks of 2012, I do not foresee HDV giving up its lead. In the New Year, the challenges facing retail investors remain great; the European Union is still plagued with turmoil and questions continue to linger regarding the growth status of leading emerging growth engines like China. This type of cloudy forecast has and will continue to benefit HDV.

That is not to say that investors should abandon DVY. Rather, in the event that skies clear, this fund should be on the radar. During periods of duress, the elder product will likely sell off harder than HDV. These magnified downturns may present attractive buying opportunities in the event that market conditions improve.

With challenges on the horizon in 2012, investors need to maintain a level head. Whether you opt for DVY, SDY, or HDV, dividend-paying equity ETFs look like strong bets for the New Year.

Written by Don Dion in Williamstown, Mass.

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At the time of publication, Dion Money Management owned the iShares Dow Jones Select Dividend Index Fund.

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