Morningstar Magazine - June/July 2017 - 85

The fund's value and profitability tilts should
continue to influence its performance. These
characteristics have been associated with higher
long-term returns, but they don't always pay off.
For example, in the United States, value stocks
lagged their growth counterparts over the fund's
life, which detracted from its performance. But its
profitability tilt gave it a small return boost.
The portfolio's turnover averaged nearly 75%
from inception through 2016 compared with
50% for the category. This higher turnover stems
from a quarterly reconstitution and optimization
approach that helps the fund react more quickly
to stocks with deteriorating fundamentals. For
example, this fund did not hold ConocoPhillips COP
in early 2016 when it cut its dividend, while many
of its peers that rely on backward-looking dividend
sustainability metrics did. Despite its high turnover,
it has not distributed any capital in its short life.

lower-yielding counterparts because they have less
of a buffer to cushion dividend payments if their
business deteriorates. To calculate a stock's quality
score, the index aggregates metrics such as
profitability (return on equity), cash flow (dividend
coverage ratio), and management efficiency
(capital expenditures scaled by sales), comparing
each stock against its sector peers. Dividendpaying stocks are grouped into quintiles within
each sector, and the lowest scoring 20% are
removed. Next, the fund uses an optimizer to
construct a portfolio that maximizes its overall
profitability score, while delivering a higher yield
than the index and matching the index's market
beta. The optimizer also limits stock, industry,
sector, and unintended style bets. Turnover is
capped to 25% at each quarterly reconstitution.
Fees

The fund targets profitable, dividend-paying
U.S. stocks and limits single-stock, industry, and
sector weightings to reduce unintended bets. The
result is a diversified portfolio that favors
high-yielding stocks with strong fundamentals. It
earns a Positive Process Pillar Rating.

This fund has a 0.37% expense ratio, less than
the 0.8% large-value median, and it earns a
Positive Price Pillar rating. But there are cheaper,
more diversified dividend-oriented strategies.
Over the trailing three years ended March, the
fund lagged its benchmark by 46 basis points per
year, more than its annual fee. This may
owe to high transaction costs because of its
frequent reconstitution.

The fund tracks the Northern Trust Quality
Dividend Index, which targets dividend-paying
stocks in the Northern Trust 1,250 Index, but
applies a proprietary quality scoring model to avoid
stocks that pay out a large share of their earnings
as dividends. These stocks tend to be riskier than

Silver-rated Schwab U.S. Dividend Equity ETF SCHD
(0.07% expense ratio) also balances yield with
quality. SCHD targets 100 stocks with high dividend
yields, return on equity, cash flow/debt, and
five-year dividend-growth rates. Its process is more

Style Map 04/30/2017

Top 10 Holdings 04/30/2017

Portfolio Construction

Giant Large Mid

Centroid:
Weighted avg. of
equity holdings

Small Micro

Zone: 75%
of fund's equity
holdings

Alternatives

Stock

Weight (%)

transparent than QDF's, and it has a higher
average market capitalization. Its sector
weightings are capped at 25%, but it looks very
different from the category at times.
Vanguard High Dividend Yield ETF VYM (0.08%
expense ratio) is a more diversified portfolio,
though it tends to have a lower dividend yield and
has a much higher average market cap compared
with QDF. It sorts U.S. dividend-paying stocks by
yield, and targets the higher-yielding half,
weighting them by market capitalization. VYM's
low fee and broad market-cap-weighted approach
support its Analyst Rating of Silver.
Bronze-rated PowerShares S&P 500 High Dividend
Low Volatility SPHD (0.30% fee) selects 50
high-yielding stocks from the S&P 500, but it seeks
to reduce risk by targeting stocks with low
volatility, rather than high profitability. SPHD
launched around the same time as QDF
and has offered a similar yield, though it tends
to have a larger market-cap orientation.
WisdomTree LargeCap Dividend ETF DLN (0.28%
fee) selects the largest 300 stocks by market
capitalization from a proprietary index that weights
holdings by the value of dividends each stock is
expected to pay over the next year relative to the
aggregate value of the portfolio. DLN's broad
diversification and weighting by dividend payment
reduce its risk and support its Bronze rating. K
Adam McCullough, CFA, is an analyst, passive strategies,
with Morningstar Research Services.

Stock

Weight (%)

Procter & Gamble PG

3.29

Apple AAPL

2.82

Wells Fargo WFC

3.25

General Electric GE

2.71

Pfizer PFE

3.19

Boeing BA

2.43

Merck MRK

2.96

3M MMM

2.41

Philip Morris International PM

2.83

Wal-Mart WMT

2.34

Deep Value Blend Growth High
Value
Growth

global.morningstar.com/Morningstarmagazine

85


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