The end of the year means it's portfolio rebalancing time, and one of the best-known rebalancing techniques is the “Dogs of the Dow” tactic of investing in the 10 highest dividend-yielding stocks in the Dow Jones Industrial Average.

This form of asset allocation has its own set of risks. It can lead to sector concentration, as sometimes stocks are trounced because of macro factors, such as what happened with energy stocks in 2015. Plus, there’s the risk of owning only 10 securities.

Three ETFs, however, use strategies that its founder claims smooths out the rough edges of Dogs of the Dow.

ALPS Funds, ALPS Sector Dividend Dogs ETF (SDOG), ALPS International Sector Dividend Dogs ETF (IDOG) and ALPS Emerging Sector Dividend Dogs ETF (EDOG) take the Dogs strategy and apply a factor-based twist, says Mike Akins, senior vice president and head of exchange traded funds at ALPS.

For SDOG, they use the S&P 500 rather than the Dow to get a broader selection of dividend-payers. ALPS takes the five highest-yielding securities in the 10 sectors (not including the newly created real estate sector) and equally weights both the stock and sector levels to get a broader diversification. This diversification means the portfolio is not influenced by the macro risks associated with the markets and instead can look at the micro or the company-specific risks associated with value or dividend-based investments, Akins says.

IDOG and EDOG take a similar approach. IDOG uses the MSCI EAFE index as its benchmark and pulls from dividend paying stocks that have passed liquidity and market cap screens, across 22 developed markets. EDOG uses the MSCI Emerging Markets Index as its benchmark and pulls from the 500 most liquid companies in the region. But ALPS also adds a 10 percent country cap to EDOG to keep equal weighting.

The funds are rebalanced quarterly and reconstituted annually, Akins says. SDOG is the oldest and biggest dog in the kennel, founded in 2012, and has $1.69 billion assets under management, with an expense ratio of 40 basis points. It’s 85 percent large-cap and 15 percent mid-cap. IDOG was born in 2013 and has $16.2 million AUM, with an expense ratio of 50 bp. It is 90 percent large-cap and 10 percent mid-cap. EDOG is the youngest pup, founded in 2014, with $19 million AUM. It has a 60 bp expense ratio and is 70 percent mid-cap, 18 percent large cap and 12 percent small cap.

SDOG is up 22.19 percent year-to-date versus the S&P’s return of 9.79 percent, according to Morningstar. Since inception, the fund is up 16.41 percent versus the S&Ps 13.96 return. Year to date, IDOG is up 0.75 percent versus the EAFE’s drop of 4.99 percent. Since inception, it has trailed the EAFE index, with a return of 2.80 percent versus 3.90 percent for the index. EDOG is roughly matching the Emerging Market Index at 10.81 percent and 10.94 respectively, but also trails the index since inception, being down 0.84 percent versus down 0.43 percent.

Akins says a bit of SDOG’s outperformance is due to timing because dividend-payers are in vogue right now, but the deep value construction, equal weighting and quarterly rebalancing also helped. That allowed the fund to sell some of their utility sector positions earlier in the year, when the sector was leading the market, and pick up health care, financials and technology, he says.

“We’re trying to smooth out the ride and not make that macro call,” he says.

IDOG and EDOG have not performed as well as SDOG, but that may be partly due to where the business cycle is for those two funds. Akins says IDOG has trailed the EAFE benchmark since inception, but he says IDOG is more in line the iShares MSCI EAFE Value ETF (EFV), which is also underperforming.
“We would recognize that value is out of favor globally and that hasn’t caught up with the business cycle,” he says.

For EDOG, he believes part of the weakness is investor disinterest in emerging markets.

Akins also points out that the three funds embrace high-conviction strategies, so tracking error will likely increase. “The best way to use a deep-value strategy is to pair it with a high-quality or a high-momentum (factor) strategy—strategies that will zig when you zag. So you have to understand how best to position it in your portfolio,” he says.

Brett Manning, senior market analyst at Briefing.com, says these ETFs, particularly SDOG and IDOG, offer a much more efficient high-dividend strategy than a straight “Dogs of the Dow” allocation because the diversification helps investors to weather macro factors.

He says IDOG’s underperformance is probably due to slower growth internationally versus the U.S., and that either IDOG or SDOG could do well at alternating times.

However, he thinks the EDOG concept is likely to underperform because investors still look at emerging markets as a whole, rather than its individual components.

“Big institutional money managers will say they’re going in for emerging markets. They won’t say we’re going to stay away from the information technology sector for the emerging markets. You’re going after emerging markets or not. It may be stupid, but that’s how it works,” he says.