My Top 3 Dividend ETF Picks For February

This month could be a prime opportunity for quality names to reassert their leadership.

Based on the first couple weeks of 2024, it looked like it was setting up to be a year for more defensive and dividend strategies to thrive. Once the latest round of positive economic numbers dropped, it was right back to the old favorites - mega-caps, tech and growth stocks.

To be fair, the high level numbers - GDP growth, unemployment and inflation - support short-term bullishness even though we’re starting to see some cracks in the labor market and the amount of debt being accumulated by consumers is getting concerning. That’s why I’ve continued to eye dividend stocks as having good potential for outperformance in 2024. As some of those under-the-radar issues start to grow larger, investors will reconsider taking some risk off the table.

The S&P 500 was up 1.6% in January, while the Nasdaq 100 gained 1.8%. The latter index had to stage a comeback after a slow start, but the magnificent 7 came to the rescue again.

The dividend ETF universe, however, didn’t nearly see that type of success. Out of nearly 100 U.S. focused dividend ETFs, just two outperformed the S&P 500.

The FlexShares Quality Dividend Defensive Index ETF (QDEF) is one I’ve highlighted in the past and is part of the issuers “quality dividend suite”. It looks for companies with strong profitability, management efficiency and reliable cash flows before optimizing the portfolio to produce a beta of between 0.5 and 1.0.

The TBG Dividend Focus ETF (TBG) is nearly brand new and uses a similar strategy to that of QDEF. It targets strong free cash flows and fundamental balance sheet strength to create a portfolio of companies that generate 1) growth of capital, 2) sustainable dividend income and 3) growth of income over time.

There are some other familiar names on January’s top performer list. The WisdomTree U.S. Quality Dividend Growth ETF (DGRW) and the iShares Core Dividend Growth ETF (DGRO) are perpetually near the top of my dividend ETF rankings. The iShares Core High Dividend ETF (HDV) is the 10th largest U.S. dividend ETF and, while its yield-weighted methodology probably didn’t do it any favors, its earnings and dividend sustainability screens probably did. The Freedom Day Dividend ETF (MBOX) may be way under-the-radar with just $90 million in assets, but its active management approach just seems to keep showing up on the monthly top performer lists.

What Worked & Didn’t Work In January

As you can see, quality continues to be a theme within dividend stocks and ETFs. Investors, on the surface, appear to still be overweighting tech and growth in their portfolios, but the fact that the quality factor continues to outperform suggests that these same investors are also layering some protection on their portfolios as well.

The high yield factor has been struggling for different reasons. This group is typically overweight to cyclical sectors, especially financials & industrials, and (when included) real estate. All of these sectors did well when the Fed first signaled the pivot back in December and interest rates on the long end of the curve began falling. Since Powell urged patience in preparing for rate cuts, yields have crept higher again and these sectors have lagged. Financials and industrials have their own sets of issues, but real estate looks like a hot mess, especially globally. Approach any real estate dividend ETF with a lot of caution right now (the Invesco KBW Premium Yield Equity REIT ETF (KBWY) was the worst performing dividend ETF in January, losing nearly 10%).

Within the largest and most popular dividend ETFs, there really wasn’t much of a discernible trend. Funds with seemingly similar strategies delivered very different performances, meaning that this could be becoming more of a picker’s market. While one pillar may very well have more success than another as we move forward in 2024, I suspect we’ll see some more disparities, leaving investors needing to dig down a little further into ETF strategies to identify what aligns with their objectives. This would apply to the broader market as well.

3 ETF Picks For February

It’s tempting to expect the current risk-on environment to keep plowing forward unless something happens to derail it. With the Fed meeting out of the way, the latest economic numbers proving positive again and much of the Q4 earnings season in the rearview, February could be a month with relatively fewer potential road bumps.

Still, I’m not buying the idea that tech and magnificent 7 have unlimited upside. Even if risk-on conditions continue, the gains in the equity market can’t keep being this narrow. I think the quality theme will continue and investors will trend towards more defensive names in the upcoming weeks. The idea of a more hawkish Fed message overcoming more dovish market expectations could be a driver.

Invesco S&P 500 High Dividend Growers ETF (DIVG)

Here’s an ETF with a strategy that I’m a little surprised wasn’t thought of sooner. DIVG will invest in 100 companies that have the highest forecasted dividend growth rate, not just a minimum number of years of consecutive dividend growth. A lot of dividend ETFs count any increase, regardless of how big or small, to be dividend growth. The fact that this ETF looks at strong dividend growth gives it, in my opinion, better growth potential in the long-run.

This ETF is tiny and tradability could be an issue until it scales up, but I don’t think there’s much questioning the strategy. It has 10%+ allocations in financials, utilities, real estate and consumer staples, so it’s going to be very interest rate sensitive and defensive. Fast dividend growth, however, requires strong cash flows and that’s something that should continue to play well.

Roundhill S&P Dividend Monarchs ETF (KNGS)

Here’s another ETF that I’m surprised took so long to get to the market. The traditional definition of “dividend aristocrat” requires a minimum of 25 consecutive years of dividend growth. KNGS looks for companies with at least 50 consecutive years of dividend growth. Not surprisingly, this fund is fairly concentrated because not a lot of companies have grown their dividend for that long. It has 40 individual holdings, but pays a relatively healthy 3.1% yield.

This, of course, is about the opposite of a growth play in your portfolio. It’s got names, such as Hormel, Kimberly-Clark and 3M, in its top 10 holdings. These are highly durable and mature businesses that should perform relatively well should investors ever shake out of their growth infatuation.

Invesco S&P Ultra Dividend Revenue (RDIV)

This is also a potential defensive position in a portfolio, but one that’s built on sales and cash flows, not current or potential dividend growth. It starts with a universe of large- and mid-cap stocks and picks out the 60 names with the highest dividend yields (excluding outliers) before reweighting the portfolio according to company revenue. It’s effectively a pure high yield play, but redistributed to tilt towards the companies better positioned to sustain that yield.

The 4.2% yield will no doubt gain attention, but I prefer the sales tilt of the names in the portfolio. Consumer spending is strong right now, but a lot of it is being done with debt and that it makes the economy susceptible to slowdowns. Companies with fewer issues generating lots of revenue could be a nice defensive way to play the market while capturing a high yield in the meantime.