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Summary Rates will rise, but very slowly, so dividend funds are still in favor. As rates rise, high-yielding funds should generate more attention. Ultra-cheap way to own some of the world’s best companies. The purpose of this article is to discuss the attractiveness of the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ) as an investment option. To do so, I will look at recent fund performance, its current holdings and allocation, and trends in the market to conclude if VYM will be a profitable investment going in to 2016. First, a little about VYM. The fund is designed to track the performance of the FTSE High Dividend Yield Index, which measures the investment return of common stocks of companies characterized by high dividend yields. Currently, the fund is trading at $68.52/share, and its most recent quarterly dividend is $.53/share. Since VYM’s dividend payment typically fluctuates throughout the year, I used Vanguard’s website directly to estimate its annual yield going forward, rather than relying on its most recent payment. Vanguard currently has its annual yield listed at 3.14%. With the Federal Reserve set to finally raise rates this month, (according to 81% of fund managers surveyed by Bank of America Merrill Lynch), it may seem to go against conventional wisdom to initiate positions in dividend funds at this time. However, there are a few reasons why I expect VYM to still outperform in this environment, which I will outline below. One, the market has been expecting rate hikes for some time, only to be continuously surprised by the Fed delays month after month. Funds such as VYM have been dropping prior to the Fed’s meetings, only to rebound sharply once the announcement of no increase is made. For example, in mid-August VYM dropped over 10% , partly on speculation that a September rate hike was evident. Since the Fed has delayed raising rates in the following two meetings, the fund has rebounded to the pre-drop levels. While VYM has not suffered a recent steep drop, it has traded cautiously over the last month, gaining under 1%. I view the potential upside to VYM, if the Fed delays yet again in December, as greatly outweighing any downside risk. In fact, while most traders are expecting a hike, they are still not completely sold on it. According to the same Bank of America Merrill Lynch survey , the possibility of a December rate hike after the release of last month’s Fed meeting minutes went down to 68%. Therefore, VYM could be a great hedge if the rate hike is delayed yet again, because the fund should rise swiftly as investors dive back in to capture the high yield. Two, I think VYM will outperform over the next six months even if rates do rise, because the increases are likely to be slow and small, meaning investors will have to wait a long time for yields to rise high enough on short-term bonds to seriously compete with the yield offered by the fund. The annual yield of over 3% will still be seen as “high” for a while, even when the Fed finally decides to begin increasing rates. Coupled with the possibility of capital appreciation, investors would be wise to stay the course with VYM, as I do not anticipate a massive correction in the fund on the first rate hike announcement. Additionally, if the Fed does decide to raise rates, the principal reason behind that decision is because they are beginning to feel more confident about the economy’s ability to stand on its own merits. Under such a scenario, I would expect the largest American companies to do well in this growing economy, and those are exactly the companies that make up the bulk of VYM’s portfolio. Below is a listing of the main holdings of VYM as of 10/31/2015: 1 Microsoft Corp. (NASDAQ: MSFT ) 2 Exxon Mobil Corp. (NYSE: XOM ) 3 General Electric Co. (NYSE: GE ) 4 Wells Fargo & Co. (NYSE: WFC ) 5 Johnson & Johnson (NYSE: JNJ ) 6 JPMorgan Chase & Co. (NYSE: JPM ) 7 Procter & Gamble Co. (NYSE: PG ) 8 Pfizer Inc. (NYSE: PFE ) 9 AT&T Inc. (NYSE: T ) 10 Verizon Communications Inc. (NYSE: VZ ) As you can see from the chart, VYM is made up of some of the biggest companies in the world, and these companies will perform strongly during periods of domestic growth. Therefore, the bulk holdings of the fund should continue to deliver returns, regardless of the Fed’s decision. Of course, investing in VYM is not without risk. While I have laid out a few reasons why I like the fund, it is certainly plausible that the Fed will raise rates more aggressively than anticipated. If rates are raised higher, or more quickly, than investors expect, the market will become more volatile and dividend funds will likely suffer as investors shift into bonds and other fixed income investments that begin to offer higher yields with less downside risks. Also, while I laid out why continued low rates will be beneficial overall for the fund, VYM does have about a 15% exposure to the financials sector. This is a sector that should actually outperform in a higher rate environment, since financial companies like banks are able to charge more for the loans they lend out, typically leading to a higher spread, and therefore profits, for the firm. If rates stay low, that sector could be a laggard, which will weigh on the overall performance of VYM. How much this will impact the fund is unclear, but it is a risk to be aware of. However, I do not expect either of these scenarios to play out. Fed chairwoman Janet Yellen has made it clear that the Fed will take a “gradual approach” to hikes to ensure the market is not disrupted. Also, I do not expect the financial sector to drag on VYM, as the sector has rallied, and all odds do point to a hike in the near future. Bottom line VYM provides investors with diversified exposure, access to some of the biggest companies in the world, all for an ultra-low fee of .10%, which, according to Vanguard’s website, is lower than that of 91% of comparable funds. With rates expected to stay at historically low levels, even after the Fed’s initial hikes, VYM’s yield of over 3% will continue to attract investor interest in 2016. The fund will also benefit from increased consumer spending, as it has a 20% weighting of direct exposure to the U.S. consumer. While recent consumer spending has not been strong , I see tremendous upside to that statistic, as hourly wages for Americans have finally started to rise . This will bode well for future consumer spending, especially going into the holiday season, and VYM will be a direct beneficiary of this trend. With a growing U.S. economy and wage growth, continued low rates, and low management fees, I would encourage investors to take a serious look at VYM. Scalper1 News
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