Written by Suzanne McGee
(Reuters) – U.S. exchange-traded funds (ETFs) focusing on dividend-paying stocks have seen a surge in investor interest since the Federal Reserve initiated its rate-cutting cycle last month. However, a rise in U.S. Treasury yields could potentially slow down the influx of funds from investors.
In September, the group of 135 U.S. dividend ETFs monitored by Morningstar attracted $3.05 billion in investments, coinciding with the Fed’s 50 basis point interest rate cut, the first since 2020. This is a significant increase from the average monthly inflows of $424 million in the first eight months of 2024.
The growing popularity of these ETFs is driven by investors seeking income-generating options in anticipation of declining yields as the Fed continues its rate cuts.
“The shift in monetary policy means that cash is seeking new investment opportunities, and dividend-yielding stocks are likely to benefit from this trend,” said Nick Kalivas, head of factor and equity ETF strategy at Invesco.
However, the sustainability of this trend remains uncertain as benchmark 10-year Treasury yields have been on the rise in recent weeks, hitting two-month highs after strong U.S. employment data suggested a resilient economy that may not require further significant rate cuts this year.
Josh Strange, founder and president of Good Life Financial Advisors of NOVA, noted that the renewed interest in dividend stocks is a response to elevated valuations in sectors like tech and broader market indices, in addition to changes in monetary policy.
With a valuation at 21.5 times future 12-month earnings estimates, the S&P 500 is approaching its highest level in three years, well above its long-term average of 15.7, as per LSEG Datastream.
Dividend ETFs offer varying yields based on their strategy, ranging from just under 2% to as high as 3.6%. In comparison, benchmark 10-year Treasuries yielded around 3.6% in September.
These ETFs typically include energy and financial stocks like Chevron Corp. (NYSE:), JP Morgan Chase (NYSE:), and Exxon Mobil (NYSE:), as well as pharmaceutical companies, utilities, and retailers.
“If you are seeking high dividend payouts, it’s essential to invest in companies that are poised for growth and capable of increasing those payouts,” said Sean O’Hara, president of Pacer ETFs, discussing the outlook for dividend ETFs in the latest edition of Inside ETFs.
To mitigate the risk of holding companies with weakening fundamentals, Pacer constructs ETF portfolios based on companies’ free cash flows, such as the $24.8 billion Pacer US Cash Cows ETF, launched in 2016, which has attracted $7.1 billion in inflows over the past year.