For years after the financial crisis, the industry's bad reputation extended to their shares, as many investors began to shun them. And now we have an interesting litmus test on whether that's a smart move courtesy of two ETFs, one of which includes financial holdings, the other doesn't.
Two WisdomTree ETFs, launched on the same day in 2006, take different approaches to domestic dividend-paying stocks. Both the WisdomTree High Dividend Fund (DHS) and the WisdomTree U.S. Dividend ex-Financials Fund (DTN) weight their holdings by projected dividend payment. That would seem to make for a fairly straightforward comparison, but the structures of these two ETFs are quite distinct.
The most obvious difference is the lack of financial stocks in DTN. Remarkably, DTN was introduced to the market 21 months to the day before Bear Stearns ceased to exist as a separate company. The demise of Bear led to a market meltdown and a recession.
We are now more than nine years removed from the start of the financial crisis and more than eight years from the onset of the current bull market. In late June, the Fed approved the most recent capital allocation plans of the major banks it supervises and many promptly raised their dividends. In light of the strength of the economy and the banks, does it make sense for advisors and their clients to avoid financials when looking at dividend-paying stocks? Did it ever make sense?
A closer look at these WisdomTree ETF siblings may help to answer those questions:
The indexes underlying both ETFs are derived from the WisdomTree U.S. Dividend Index (DI), which includes all U.S. companies that pay dividends on their common stock. WisdomTree High Dividend Fund (DHS, expense ratio: 0.38%) includes the top 30% of the issues in the DI, ranked by dividend yield. Stocks must have a minimum market capitalization of $200 million and average daily dollar volume of at least $200,000 for the three months prior to screening. The $1.2 billion fund holds more than 400 positions. Largest sector representation is consumer staples (17.3%), followed by real estate (12.4%), and health care (11.5%). Financials are 10th at 5.8% of the portfolio. The fund’s 10 biggest holdings represent 32.6% of assets. As of August 7, the ETF’s 30-day SEC yield was 3.32%. Since inception, the annualized return of DHS has been 6.76%.
WisdomTree U.S. Dividend ex-Financials Fund (DTN, 0.38%) removes financial stocks from the U.S. Dividend Index and then selects the 300 largest companies by market capitalization. From this group, the highest yielding stocks in each sector form DTN. The $865 million fund recently held 81 stocks. Largest sectors are utilities (16.5%), consumer discretionary (11.8%), and energy (11.6%). The top 10 holdings in the ETF are 19.3% of its assets. WisdomTree follows the Global Industry Classification Standard (GICS), developed jointly by MSCI and Standard & Poor’s. Until recently, the GICS system included real estate as a subcategory of the financial sector. Real estate became a separate sector in September 2016, but DTN still excludes REITs along with financials. As of August 7, the fund’s 30-day SEC yield was 3.41%. Since inception, DTN’s annualized return has been 8.38%.
Looking at performance, removing financials helped DTN beat DHS over the past five- and 10-year periods. Sharpe ratios for DTN over those periods (1.29; 0.51) were also better than those for DHS (1.26; 0.40). Yet the resurgence of the banks may have helped DHS more recently. Over the past three years, it had an annualized total return of 9.82% and a Sharpe ratio of 0.99 vs. DTN’s 8.73% and 0.86. It would be reasonable to conclude that the more inclusive approach to dividend-payers exemplified in DHS portfolio has finally escaped the long shadow of the financial crisis.