New Vanguard High Dividend Yield ETF: Questioning The Methodology

Into the already crowded space of dividend ETFs enters a new fund from Vanguard. It's called the Vanguard High Dividend Yield ETF, tracks the FTSE High Dividend Yield Index and trades under the symbol VYM.

Vanguard is the proverbial 500-pound gorilla in the index fund business. Any offering they come up with is bound to be a contender. At the very least, it's worth looking at.

The FTSE index they track is proprietary, and comes with a legal warning that prevents me from doing my usual dissection of individual holdings. Suffice it to say that the index is basically the top yielding half (in terms of market cap) of the total US market, minus REITs and non-payers.

What they end up with is a 2.9% yielding index of over 500 stocks, which they provide at an expense ratio of 0.25% (in the ETF format - there is an equivalent mutual fund that charges 0.4%). This figure makes the VYM the cheapest dividend fund in the US - better than the 0.28% offered by the WisdomTree flagship (DTN) and the 0.4% charged by the benchmark DVY.

But while expenses matter, so does style and for that matter, methodology. The VYM tends to be more of a large-value offering than a dividend offering. The index has a dividend yield of just under three percent, which is a good half percent lower than the DJ Select Index. It makes no attempt to quantify dividend growth, consistency or "quality". As far as the VYM is concerned , only the dividends paid this TTM matter.

Neither does it give a 5% yielder any preference over a 3% yielder, as long as they get in the index. All this keeps their index simple, their execution easier and their costs down. But perhaps it does not capture the dividend theme as well as some of the other funds do.

To make things concrete: VYM's 5th largest holding (3.2% of assets) is Procter & Gamble (PG) which yields well under 2%, and is nowhere to be found in the top 25 holdings of DVY. PG is probably a sound value stock. But it's not a shout-it-out-loud dividend payer.

For these reasons, I wouldn't substitute my core equity income holding (namely, the DVY) for the VYM. It falls just short of that. But I like VYM as a cheap way to gain exposure to large-value stocks, with a hint of yield, and the added value of Vanguard's track record to boot.

Full Disclosure: Author is long DVY.