Over the past 5 years, few themes have more consistently resonated with ETF investors than equity income.1 Since 9/30/2009, equity income ETFs have collectively gathered over $50 billion in net inflows, with positive net inflows in 19 out of the last 20 quarters.2 This recent popularity can largely be attributed to investors' growing appetite for income in a yield-starved interest rate environment, combined with the perception that dividend-paying stocks may be less risky than non-dividend payers.
As we've discussed in previous newsletters, however, one of the risks that investors face with equity income ETFs is sector concentration. While there is nothing inherently wrong with overweighting certain sectors while underweighting others, large sector bets may produce unexpected or undesirable results. For example, on 9/30/08, just before the collapse of the financial services sector, equity income ETFs allocated an asset-weighted average of 42.6% to financial stocks, representing a 26.6 percentage point overweight relative to the S&P 500 Index.3 Unfortunately for investors, financial stocks suffered extreme negative returns over the next 6 months. Interestingly, the financial sector is currently the second most underweight sector within equity income ETFs, relative to the S&P 500 Index.4 Conversely, utilities and consumer staples are the two most overweight sectors within equity income ETFs, with average allocations 8.1 and 7.0 percentage points higher than the S&P 500 Index, respectively.5
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1Included in this group are non-sector US equity ETFs whose names suggest a "dividend" or "income" strategy.
2Morningstar Direct, as of 9/30/14.
3Morningstar Direct. As of 9/30/14, there were 17 US listed equity income ETFs. ETF AUM-weighted average sector allocation is used in this comparison to best represent the sector allocation of most investor dollars.
4Morningstar Direct, as of 9/30/14.
5Morningstar Direct, as of 9/30/14.