First Trust Morningstar Dividend Leaders ETF (FDL)

The First Trust Morningstar Dividend Leaders ETF (FDL) holds the shares of large, profitable companies that pay above-average dividends to shareholders, chosen with help from Morningstar’s research.

Dividends: income from stocks you own

A dividend is money a company pays to its shareholders out of profits. It is simple. You own 100 shares of a bank, the bank earns a lot of money, and rather than keeping every penny, it sends you a check — or deposits cash to your account — four times a year. The bank might pay two dollars per share per year, meaning you collect two hundred dollars on your hundred shares.

Not all stocks pay dividends. Young, fast-growing companies like Amazon or Tesla typically reinvest all their profits into the business — building new warehouses, funding research, buying other companies — and send nothing back to shareholders. They are banking on the share price rising. Mature, slower-growing companies — the ones with stable profits and limited expansion opportunities — often do the opposite. They have more cash than they can usefully invest, so they hand it back. Banks, oil companies, utilities, consumer staples, and real estate investment trusts are the classic dividend payers.

FDL is a bundle of these stocks. Rather than owning a little bit of every large company, FDL owns only the ones paying above-average dividends and then selects among those based on research from Morningstar, an investment research firm. The goal is to give investors a steady stream of income from dividend checks while also keeping the potential for stock-price appreciation.

How Morningstar helps choose the stocks

First Trust, the fund issuer, is a large investment company. Morningstar is a independent research firm famous for rating mutual funds and stocks. The two partnered to create FDL: Morningstar selects stocks that meet certain criteria — they must be large, solvent, and consistently profitable — and then ranks them by dividend yield (the dividend paid divided by the stock price) and other quality metrics. First Trust then buys a basket of the top-ranked names.

This is a form of stock-picking, lighter than a traditional actively managed fund but more involved than a pure index tracker. It is based on the belief that Morningstar’s research can identify companies most likely to sustain and grow their dividends over time. A company might have a high dividend yield today but be on the verge of cutting it — that is a value trap, not a bargain. Morningstar’s methodology tries to distinguish healthy, growing dividends from ones about to blow up.

The cost is a moderate expense ratio and the risk that Morningstar’s judgment is off. Over longer periods, the fund’s returns should match what you would get from a similar basket of stocks selected by other means — but in any given year or market cycle, the bets can pay off or backfire.

Stability and income in a cyclical market

The stock market cycles through boom and bust like the weather. In booms, growth stocks soar and dividend stocks lag. In busts, growth stocks plummet and dividend stocks often hold up better because they are large, profitable, and the income floor gives them a value anchor. FDL, as a collection of stable dividend-payers, tends to smooth out the ride.

Consider a recession. A high-growth tech stock might fall 50 percent. A big bank or utility in FDL might fall 20 percent. But the owner of FDL is still collecting dividends — usually, the bank or utility will maintain or even grow its dividend despite the downturn because it has strong cash flows. So the total return loss is less catastrophic.

That said, dividends are not sacred. In severe recessions or financial crises, even blue-chip dividend stocks sometimes cut their dividends to preserve cash. In 2008, many banks slashed dividends to zero. So FDL is more stable than a growth-stock fund, but it is not shock-proof.

Who FDL is for

FDL appeals to two main types of investor. First, retirees or others living on investment income. If you need the money that stocks generate to live on, FDL’s income stream is literal cash in your pocket every quarter. It beats holding only bonds, because you get the dividend plus the chance of stock appreciation.

Second, investors who believe dividend stocks are undervalued relative to the market and want to tilt their portfolio toward them. The bet here is that over time, large, profitable, dividend-paying companies will outperform faster-growing but less profitable peers because they offer better true return — the combination of dividend income plus capital appreciation.

The danger of FDL is that it can underperform for long stretches during bull markets driven by growth stocks. From 2010 to 2021, technology stocks soared while dividend stocks lagged. An investor who overweighted FDL during that period gave up significant gains. Conversely, from 2021 to 2024, as growth stocks stumbled and interest rates rose, dividend stocks rebounded, and FDL outperformed.

Plain research for FDL investors

To understand FDL, start by looking at its top ten holdings — these are usually the largest, most established companies in the world: energy majors, banks, consumer staples, utilities. Check their individual dividend yields. Then compare FDL’s average dividend yield to the yield of the overall stock market (often measured by the S&P 500). If FDL’s yield is 4 percent and the market’s is 1.5 percent, you are clearly getting income. But check whether those dividends have been growing or stable, which signals the companies are healthy.

Look at the fund’s returns over the past three, five, and ten years, and compare them to a simple broad market index fund. If FDL has underperformed, it might be a bad time to buy (the whole dividend strategy is out of favour). If FDL has outperformed, the opposite might be true.

Finally, think about your own situation. Do you need the income? Can you stomach a 30 percent decline in the stock price in exchange for collecting steady dividends? If the answer is yes, FDL is a sensible tool. If you are young and can reinvest the dividends, FDL’s income is less relevant, and a broad market fund might serve you better.