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The SPDR Portfolio S&P 500 High Dividend ETF Owns Some High-Risk Dividend Stocks – Is It Still Worth Buying?

With a dividend yield of around 4.4%, the SPDR Portfolio S&P 500 High Dividend ETF (SPYD -0.32%) lives up to its name. For comparison, the SPDR S&P 500 ETF Trust (SPY -0.12%) has a yield of just about 1.3%. You need to understand how the high dividend ETF achieves a yield that’s three times as high as the broader S&P 500 index before you buy it.

This High Dividend ETF has a simple approach

The SPDR Portfolio S&P 500 High Dividend ETF is a fairly simple exchange-traded fund to understand. It just selects the 80 stocks with the highest dividend yields from the S&P 500.

The stocks that are selected for the portfolio are then equally weighted, which ensures that each holding has the same impact on performance, for better or worse. That’s a really straightforward approach for an ETF.

That said, you can’t just take the starting stock pool without truly considering what it means to be in the S&P 500 index. Companies make it into the index because they are large, U.S.-based companies that, as a group, provide a fair representation of the economy.

This process ensures that the companies are reasonably important. And that means that the selection pool for this ETF is a fairly good one. But there are still a couple of not-so-small problems here when the only selection consideration is dividend yield.

What does the S&P 500 High Dividend ETF own?

When companies are placed into the S&P 500 index, that doesn’t mean they will always be large, important, and representative of the broader economy.

The business fortunes of companies wax and wane over time, which is why those in the S&P 500 index are updated on a regular basis. Companies that are no longer up to snuff are removed, and new ones that are more appropriate are added.

Often companies are removed after a long period in which they have underperformed for some reason. Such companies often have high yields because investors tend to shun underperformers.

For example, Altria Group is in the SPDR Portfolio S&P 500 High Dividend ETF because of its huge 8.4% dividend yield. But ongoing declines in Altria’s cigarette business have left the stock nearly 40% below its 2017 high-water mark. It has been a drag on this ETF’s performance for years, and it isn’t the only stock in the ETF that’s been a laggard.

MO data by YCharts.

You could persuasively argue that the SPDR Portfolio S&P 500 High Dividend ETF’s approach gives it something of a value or contrarian bent. But investors looking for income might not want to take on the risks associated with contrarian or value investing.

There are other dividend-focused funds, such as the Schwab U.S. Dividend Equity ETF (SCHD -0.24%), that specifically try to find high-quality dividend stocks. You have to give up some yield for that, with the Schwab ETF’s yield at 3.4%, but for conservative investors, that trade-off might be worthwhile.

Then there’s the question of sector allocations. Some sectors of the market tend to have higher yields than others. A good historical comparison would be between the utility and technology sectors. The Utilities Select Sector SPDR Fund (XLU -1.09%), which is simply the utility stocks in the S&P 500 index, has a yield of 3% or so. The Technology Select Sector SPDR Fund (XLK 0.23%) has a yield of 0.7%. Needless to say, this has a big impact on the SPDR Portfolio S&P 500 High Dividend ETF’s portfolio.

XLU data by YCharts.

The largest sector in the SPDR Portfolio S&P 500 High Dividend ETF is real estate at around 26% of assets, followed by financials at 20% and utilities at 18%. All in, just these three sectors account for nearly two-thirds of the ETF’s assets. While it owns 80 stocks, it lacks diversification in other ways.

For reference, technology is less than 2% of the fund even though it is the largest sector in the S&P 500 at around 31% of that index’s assets. Putting it a different way, the SPDR Portfolio S&P 500 High Dividend ETF is not representative of the broader economy.

Not a bad ETF as long as you know what you are buying

The SPDR Portfolio S&P 500 High Dividend ETF is clearly a high-yield ETF, and its methodology is fairly easy to understand. It could be a good option for a lot of dividend investors, but probably not all dividend investors.

And the key factors here all go back to the simplistic selection criteria that can leave the exchange-traded fund holding out-of-favor stocks, with a large percentage of assets in a very small number of industries. If you are looking for passive income, you could consider the SPDR Portfolio S&P 500 High Dividend ETF, but make sure you understand the negatives here before you buy it.

This post appeared first on fool.com

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