Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / The Hidden Diversification Inside Dividend ETFs
Transcript
- Lucas: So you look at a dividend ETF like VYM and think you're getting a diversified basket of income stocks. But beneath the hood, the sector weights are shifting quietly, and that matters more now than it did a year ago. Luna: Because the yield curve is flattening again and the Fed hasn't ruled out a July rate hike. Sector exposure can make or break a dividend portfolio when rates move. Lucas: Exactly. Let's put a number on it. VYM, the Vanguard High Dividend Yield ETF, now holds roughly 19 percent in financials, up from about 15 percent in mid-2024. That's a meaningful shift. Meanwhile, its consumer staples weight has drifted down. Luna: And SCHD, the Schwab U.S. Dividend Equity ETF, has been doing something similar. Its top sector is still financials, but it's actually trimmed consumer staples more aggressively. Lucas: Right. And this isn't just index drift. These ETFs rebalance periodically, and their methodologies — especially for SCHD, which screens for dividend yield, quality, and strength — are pulling in more banks and insurers right now. Luna: Which is interesting because financials have been relative beneficiaries of higher rates. Their net interest margins widen. But that also means these ETFs are getting a beta tilt they might not advertise. Lucas: That's the hidden diversification angle. On the surface, both ETFs yield around 3.3 to 3.5 percent. But the underlying correlation between their top holdings — say JPMorgan versus Procter & Gamble — is much lower than it would be if they both piled into the same defensive sectors. Luna: And if you own both VYM and SCHD, you might think you're diversifying, but you could be doubling down on financials without realising it. Lucas: Let's look at DVY, the iShares Select Dividend ETF. It's even more concentrated in financials and utilities — about 28 percent financials, 20 percent utilities. That's a very different risk profile from VYM or SCHD. Luna: So someone who owns DVY for income is actually making a pretty big bet on interest rate sensitivity and regulatory risk. Lucas: And that's fine if you know that's what you're doing. The problem is most investors pick an ETF by its yield and expense ratio, not by its sector composition. The data from the last few quarters shows that these internal rotations have been accelerating. Luna: What's driving it? Is it just the yield curve, or are the index methodologies themselves shifting? Lucas: Both. Take SCHD's methodology — it ranks stocks by dividend yield, then by quality metrics like return on equity and payout ratio. As financials have improved their ROE and kept dividends growing, they've moved up the ranks. Meanwhile, some consumer staples like Procter & Gamble have seen their dividend growth slow, so they get a lower score. Luna: And that's actually a feature, not a bug. The fund is dynamically adjusting toward sectors with better fundamentals. Lucas: But it also means the fund's exposure to the broader economy changes. If you bought SCHD three years ago as a defensive income play, you now have a much more cyclical portfolio than you started with. Luna: Which brings us to the question: should dividend investors be rebalancing manually? Or just trust the ETF? Lucas: I think the answer is: know what you own. If your goal is steady, low-volatility income, you might want to pair a dividend ETF with a separate allocation to utilities or consumer staples to offset the cyclical tilt. Or choose an ETF that explicitly targets low volatility dividends. Luna: But that adds complexity. For the average listener, what's the simplest action to take after this episode? Lucas: Go to your ETF provider's website and pull the latest fact sheet. Look at the sector allocation. Compare it to what it was a year ago. If the percentage in financials has jumped more than five points, ask yourself if that aligns with your market outlook. Luna: Because right now, with the ten-year yield at 4.56 percent and the two-year at 4.21, the spread is just 35 basis points. That's a flat curve. Financials tend to do okay in that environment, but if the curve invert again or if the Fed actually hikes, that could change quickly. Lucas: And that's the thing about dividend ETFs — they feel like set-it-and-forget-it investments, but they're not static. The underlying portfolio is always moving. I'd argue checking sector allocation once a quarter is more important than checking the dividend yield. Luna: I think that's a great rule of thumb. And it's exactly the kind of thing we try to highlight on this show — the stuff that's easy to miss but matters. Lucas: Speaking of that, we deliberately keep this podcast ad-free. No sponsors, no commercial breaks. If you find value in these conversations and want to support that choice, the link is buy me a coffee dot com slash fexingo. It's a small way to keep this independent. Luna: Yeah, it really helps. And we appreciate every supporter who makes that possible. It lets us focus on the data and the analysis without any outside influence. Lucas: So back to the diversification angle. Another thing I find fascinating is how these ETFs are handling the energy sector. VYM still has a decent weight in Exxon Mobil and Chevron, but those positions have been trimmed over the past year as oil prices stabilised. Luna: And SCHD never had much energy to begin with. Its methodology tends to favour steadier dividend payers, so it's underweight the more cyclical energy names. Lucas: Right. So if you own VYM, you get some commodity exposure built in. If you own SCHD, you don't. That's another hidden difference that affects how your portfolio behaves when oil spikes or drops. Luna: It's like each ETF has a personality that's not captured by the yield number alone. Lucas: Exactly. And I think that's the takeaway: don't buy a dividend ETF for the yield. Buy it for the portfolio construction. Know what sectors it gives you, and make sure they complement your other holdings. Luna: One last thing — for investors who want to stay in dividend ETFs but are worried about the financials overweight, is there a simple fix? Lucas: You could pair a dividend ETF with a utility ETF or a REIT like Realty Income to balance the sector exposure. Or you could look at an international dividend ETF, which would have a completely different sector mix dominated by European and Asian financials and consumer staples. Luna: That's a good point. And it ties back to something we discussed a few episodes ago: international dividend stocks as a diversifier. Lucas: So the bottom line: check your ETF's sector allocation, compare it to last year, and decide if the drift matches your intentions. That's a five-minute exercise that can save you from a nasty surprise. Luna: And if you do that, you'll be ahead of most investors. Thanks for listening.