The Wall Street Journal-20080212-Dividend Focus May Hold Subprime Bite- Funds That Sought Yield In Financial Stocks Take Hit From Selloff in Sector

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Dividend Focus May Hold Subprime Bite; Funds That Sought Yield In Financial Stocks Take Hit From Selloff in Sector

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Investors in exchange-traded funds that focus on dividends have received a nasty surprise in recent months.

These funds often have significant stakes in high-yielding financial stocks. The sector has been hit hard by the selloff in banks exposed to the subprime rout and credit upheaval.

The largest dividend-oriented ETF, iShares Dow Jones Select Dividend Index Fund, has been one of the industry's biggest success stories, benefiting from dividend tax breaks and low bond yields.

The fund tracks an index of the 100 highest dividend-yielding securities listed in the U.S. Companies in the benchmark must have positive dividend-per-share growth in each of the past five years.

The index has liquidity requirements and takes steps to ensure that a company isn't paying out too much in dividends, which can be a sign of distress. Essentially, a company cannot pay out more than 60% of earnings as dividends. Stocks are ranked by dividend rather than by market valuation; real-estate investment trusts aren't included.

Like other dividend ETFs, the iShares fund has suffered from a heavy commitment to financial stocks. The sector accounts for almost 50% of the ETF's assets, according to the sponsor, Barclays Global Investors. The next-largest sector holding is utilities at about 18%.

The dividend ETF, which has an expense ratio of 0.4%, plunged in late January along with the broader market, hitting a 52-week low of $50.85 on Jan. 22 -- about 33% below its May 2007 high. For the 12 months through Feb. 7, iShares Dow Jones Select Dividend was down 10%, trailing the Standard & Poor's 500 Index by more than four percentage points, according to investment researcher Morningstar Inc.

Assets in the dividend ETF, which started trading in November 2003, peaked at $9.1 billion in May 2007, according to research from Banc of America Securities. Late last week, the fund's assets stood at about $6.3 billion as a result of investor withdrawals and the market decline.

"Recent indications are that investors want their money back," wrote Banc of America Securities' chief U.S. investment strategist Thomas McManus in a Jan. 22 research note, pointing to redemptions of $250 million in the preceding weeks.

Financial-services firms in the ETF's top-10 holdings include PNC Financial Services Group Inc., Comerica Inc., Bank of America Corp., Regions Financial Corp. and KeyCorp.

Although these banks are affected generally by the housing slump, the ETF has suffered perhaps unjustifiably due to the subprime panic because the majority of mortgage write-downs have struck financial- services giants such as Citigroup Inc. and Merrill Lynch & Co.

"Investors use black paint with a wide brush, even though the subprime mortgage mess is largely confined to very big banks," said John Prestbo, executive director of Dow Jones Indexes, a unit of Dow Jones & Co., publisher of The Wall Street Journal.

Mr. Prestbo said the iShares Dow Jones Select Dividend holds smaller, regional and local banks with a good history of dividend payouts and increases. Because the index orders stocks by dividends, smaller-cap banks can find their way in if they have large payouts.

Still, Matthew Hougan, editor at IndexUniverse.com, said it is important for investors to study the differences in the dividend ETFs' approaches before committing money.

"These dividend ETFs were to an extent presented as alternatives to traditional market exposure," he said. "They were put out there as a mainstream way to go after the whole market, but the poor returns recently have showed what you could have found out with a little digging -- these ETFs can have significant sector bets."

He noted that iShares Dow Jones Select Dividend has almost 70% of assets concentrated in just two sectors: financials and utilities. "Investors have to be aware of the sector allocations," Mr. Hougan said. "Maybe this is a wake-up call that these dividend ETFs shouldn't be considered mainstream funds."

Fidelity Assets at a Record

Mutual-fund company Fidelity Investments said its brokerage business saw clients assets touch a record $1.99 trillion in the fourth quarter, up 17% from a year earlier.

The Boston-based financial-services giant said daily average commissionable trades rose 30% from the previous year to record levels. Fidelity's net new client assets rose 32% to $58.5 billion, and total client accounts rose 5% to 18 million in the fourth quarter.