By Virginia Munger Kahn

With government bond yields scraping decade-old lows and corporate profits remaining strong, investment advisors and their clients are turning to dividends to generate income. In fact, recent yields on stocks now surpass the yield of the 10-year Treasury note to the tune of 2.67% and 2.2% for the Dow Jones Industrial Average and the S&P 500, respectively, versus 2.15% for the 10-year note.

Not surprisingly, while many equity fund categories are experiencing outflows, dividend-focused exchange-traded funds are experiencing healthy inflows. Through the end of August (most recent available figures), 20 ETFs with "dividend" in their name attracted $6.5 billion in net inflows, according to Financial Research Corp. in Boston. That's on a pace to outrun last year's $8.2 billion in net flows to the group.

By comparison, the SPDR S&P 500 generated $3.6 billion in net flows through August, but saw outflows of $5.7 billion in 2010.

Dividend ETFs have generated positive flows every year for the last eight years.  "Despite a very tough economic environment, these funds have been able to attract decent flows," says Veerendra Virkar, research analyst at FRC. "I would expect sponsors to introduce other dividend-focused ETFs in the future."

Four new dividend ETFs have been launched so far this year.

The three biggest dividend ETFs in terms of assets have dominated cash flows this year. Tops in asset gathering has been Vanguard Dividend Appreciation, which attracted $2.6 billion in new money through August and now has $7.1 billion in assets, although some of those inflows are investors converting to the ETF from the mutual fund share class, cautions Michael Rawson, ETF analyst at Morningstar.
Next most successful at gathering assets has been the SPDR S&P Dividend ETF, which attracted $1.1 billion in net flows and has $5.9 billion in assets. The iShares Dow Jones Select Dividend Index, which has $7 billion in assets, attracted $902 million in net cash through August.  

The Vanguard Dividend Appreciation ETF is benefitting from its good long-term track record--the fund has outperformed the S&P 500 over the past five years by returning 1.02% annually versus a 1.18% loss for the index. The fund also benefits from Vanguard's reputation for low fees and sports a puny expense ratio of 0.18%, which is lower than other dividend ETFs.

The fund's drawback is that its dividend yield of 2.35% is not much better than the S&P 500 index. Despite its name, the Vanguard Dividend Appreciation fund is more of a play on "quality" than income, Rawson says. The fund screens for stocks that have increased their dividends in each of the last 10 years. Non-liquid stocks and companies that may not be able to continue growing their dividends are weeded out. The result is a portfolio of high-quality companies such as Procter & Gamble and Coca-Cola.  

Investors looking for a fatter dividend from Vanguard may want to focus instead on the Vanguard High Dividend Yield ETF, which also has an expense ratio of 0.18% but yields 3.14%. This ETF screens for a more broadly diversified universe of dividend paying stocks instead of those that have consistently raised their dividends, Rawson says. The ETF, which has $1.7 billion in assets, has returned 1.92% annually over the past three years versus 1.23% for the S&P 500.

The SPDR S&P Dividend ETF is even more fussy about its requirements than is the Vanguard Dividend Appreciation fund. This ETF invests only in companies that have increased dividends for 25 years. These stocks are then yield-weighted in the portfolio. The result is a focused portfolio of about 60 names that yields 3.56%. The ETF has an expense ratio of 0.35% and it has outperformed the S&P 500 over the past five years by returning 0.27% annually versus the index's negative performance.

The iShares Dow Jones Select Dividend Index ETF, while one of the oldest dividend ETFs, is "a bit of an oddball," Rawson says. It invests in 100 stocks with high dividend yields and then weights them based on the dividend per share. The result is a portfolio tilted toward deep value and smaller cap stocks.  The fund yields 3.82% and has an expense ratio of 0.40%. However, it has underperformed the S&P 500 over the past five years, losing an average 2.4% a year.

Projected Dividends
Noteworthy among dividend ETF offerings are two new funds--the Global X SuperDividend ETF and the Guggenheim ABC High Dividend ETF. While full-year yields cannot be calculated on these two funds because they both were created in June 2011, Morningstar does calculate projected dividend yields based on estimated dividends for the current fiscal year divided by the most recent month-end stock price. Estimated dividends are based on the most recently reported distribution and average five-year growth rates. Based on those calculations, the Global X SuperDividend ETF has a projected dividend yield of 14.3%, while the Guggenheim ABC High Dividend ETF has a projected yield of 11%. The S&P 500 has a projected dividend yield of 2.48%.

But investors shouldn't put too much stock into these projected yields. "No one can pay that kind of rate on a continual basis," says Justin Young, head of sales at Global X Funds. In the case of the Global X fund, he notes the ETF pays dividends on a monthly basis rather than quarterly. Companies tend to go ex-dividend during end-of-quarter months, producing larger dividend payouts in those months. The latest projected dividend yield for the Global X SuperDividend ETF, for example, is based on robust end-of-third-quarter dividend payouts.

"Since less companies will be going ex-dividend next month, we expect to see a distribution yield lower than the October distribution yield," Young says. "Since we pay out the dividends as they come in, the distribution will fluctuate on a monthly basis."

The Global X SuperDividend ETF screens for the 100 highest yielding stocks in the world, which are then equal weighted in the portfolio. Once a quarter, the index provider screens out companies that have cut or have forecast they will cut the dividend, but unlike other dividend ETFs, there are no screens for dividend stability, says Bruno del Ama, CEO at Global X Funds.

But as Rawson notes, "there's no free lunch in the market." Large dividend yields tend to come from stocks that have fallen substantially or are likely to cut their dividend in the future. The fund's expense ratio is 0.79%.

The Guggenheim ABC High Dividend ETF focuses its investments in three commodity-rich countries--Australia, Brazil and Canada. "We believe over time these economies will benefit from continued growth in demand for commodities," says David Botset, senior vice president at Guggenheim Funds.

The fund invests in the ten highest yielding stocks subject to minimum liquidity requirements. The result is a portfolio of 30 stocks. The top yielding stock in the fund is Superior Plus Corp. of Canada, which recently yielded a whopping 18.9%. Since January 2010, the stock has fallen by more than 50%. "We expect this fund to be more volatile than other international funds," says Patricia Oey, ETF analyst at Morningstar. The fund has an expense ratio of 0.65%.

The bottom line is that advisors can expect plenty more dividend ETF choices in the future. "This is an area of high interest," Rawson says.