US Dividend ETFs Attract Investor Interest Following Major Fed Rate Cut

By Suzanne McGee

U.S. exchange-traded funds (ETFs) focused on dividend-paying stocks have seen a significant influx of investments since the Federal Reserve began its rate-cutting initiative last month. However, rising U.S. Treasury yields may dampen this wave of investor interest.

According to data from Morningstar, the 135 U.S. dividend ETFs experienced inflows of $3.05 billion in September, coinciding with the Fed’s decision to lower interest rates by 50 basis points—the first rate cut since 2020. In comparison, the average inflow during the first eight months of 2023 was only $424 million per month.

This surge in popularity can be attributed to investors seeking income-generating assets as yields are projected to decline with ongoing rate cuts from the Fed. Nick Kalivas, head of factor and equity ETF strategy at Invesco, noted, “The pivot in monetary policy translates into cash looking for new homes, and dividend-yielding stocks will be one of the beneficiaries.”

The sustainability of this trend is uncertain; benchmark 10-year Treasury yields have recently climbed to two-month highs. This increase came after strong U.S. employment data suggested that the economy could withstand fewer large rate cuts this year.

Additionally, Josh Strange, founder and president of Good Life Financial Advisors of NOVA, pointed out that renewed interest in dividend stocks is partly a response to rising valuations in sectors like technology and the broader market, coupled with changes in monetary policy. As per LSEG Datastream, the S&P 500 is trading at a valuation of 21.5 times future 12-month earnings estimates, nearing its highest level in three years and significantly above its long-term average of 15.7.

Strange commented, “The S&P 500 has become increasingly concentrated in just a few names, with momentum focusing around AI, making these stocks look frothy.”

Dividend ETF yields vary by strategy, ranging from just under 2% to as high as 3.6%. In comparison, 10-year Treasury yields hovered around 3.6% in September.

Common sectors represented in dividend ETFs include energy and financial stocks, as well as pharmaceutical companies and utilities. Key names may include major corporations in these sectors.

Sean O’Hara, president of Pacer ETFs, emphasized the importance of balancing high dividend payouts with growth potential. He noted that to mitigate the risks associated with companies that are underperforming, Pacer constructs ETF portfolios based on free cash flows, exemplified by the $24.8 billion Pacer US Cash Cows ETF, which launched in 2016 and has seen $7.1 billion in inflows over the past year.