DES: Strong Dividend Yields On This Small Capitalization Dividend ETF
Summary DES offers a dividend yield of 2.93%, which is a nice yield for a small capitalization ETF. The top holding has a heavy weight and offers a compelling yield of nearly 7% with an addictive product. The ETF has a mediocre expense ratio. I’d prefer to see a more defensive sector allocation to reduce the potential for losses during bearish market events. The WisdomTree SmallCap Dividend ETF (NYSEARCA: DES ) looks great. After readers suggested I take a look at the portfolio, I decided it was time to dive inside and see what I could find. This is a great ETF. Investors may quibble on whether the allocations are perfectly or merely good, but there is far more to like than to hold against the fund. Expenses The expense ratio is a .38%. I’d really prefer to see a lower expense ratio, but I find myself saying that often. When it comes to long run return projections, I have a hard time believing that gross returns on assets for ETFs with higher expense ratios will be high enough to cover that expense ratio while still providing superior returns to the market once adjusted for risk. Dividend Yield The dividend yield is currently running 2.93% according to Seeking Alpha’s numbers. I’m pretty happy with that for a dividend ETF. After accounting for this dividend ETF focusing on small capitalization companies, I’m even more impressed by that healthy dividend yield. This could be a viable option for income investors seeking a little small cap exposure in their portfolio while requiring their positions to pay a respectable dividend yield. Holdings I grabbed the following chart to demonstrate the weight of the top 10 holdings: (click to enlarge) The heaviest weighting by a substantial margin was given to the Vector Group (NYSE: VGR ). The stock has an incredibly high 6.9% dividend yield and Greg Vanderford highlighted the company as one of the most overlooked sin stocks . The company is in the cigarette business. While I’m not thrilled with the actions of tobacco companies, the dividend is very strong and their product benefits from being highly addictive. For the investor addicted to reliable income, this is an industry that simply makes great financial sense. Going a little further down the list we see SeaWorld Entertainment (NYSE: SEAS ) is another one of those sin stocks in my book. While “sin stocks” are usually used to refer to companies producing products like cigarettes and alcohol, I have to include SeaWorld in that category for their treatment of animals. Many investors may get past this, but this is a company that I’ve boycotted for a long time. The dividend yield is a strong 4.24%, but I don’t like the risk here. The potential for public backlash creates a significant risk to the business practice. This problem exists for tobacco companies as well, but SeaWorld doesn’t have the benefit of selling an addictive product. Sectors (click to enlarge) This is a very interesting sector allocation. Frequent readers know that I tend to love consumer staples as a way to reduce the risk in a portfolio, but I find those companies also tend to have respectable dividend yields. In a dividend ETF focused on small capitalization companies, the high yield was achieved while running a very different allocation strategy. Normally I think of dividend portfolios as being fairly defensive, but this is what I would consider an aggressive dividend portfolio. The industries, such as consumer discretionary, are generally expected to perform significantly better in a prolonged bull market and worse in a bear market. Despite being fairly aggressive, I have to appreciate that they incorporated utilities with a respectable weight. It may only be 11%, but many dividend ETFs underweight the utility sector. That is something the investor can deal with by grabbing a separate ETF with the utility exposure, but this one incorporated it which is nice for adding a little stability to a pat of the market that is generally going to be more volatile than the S&P 500. Volatility I ran a regression on DES and compared it with the S&P 500 since June of 2006. The annualized volatility on DES was materially higher at 27% compared to 21.1% for SPY and during the market crash shares had a max drawdown of 65.6% which is fairly massive. Since then the ETF has not been able to catch up with SPY which may largely be a function of how severe the losses were during the downturn. Conclusion DES offers investors a fairly substantial dividend yield on small capitalization investments. For the dividend focused investor, this is a viable way to get access to smaller capitalization companies, but it does have a very significant amount of volatility so investors would be wise to ensure that the position is used as part of a larger diversified portfolio. If I could change a few things, I would be lowering the expense ratio, kicking out SEAS, and increasing the allocation to more defensive sectors to reduce the potential for losses during a weak market.