It may be time to go diving for dividends.
A strong start to the third-quarter earnings season has boosted stocks, but as risks tied to monetary policy and U.S.-China trade linger, buyers may be looking for gains beyond just those of the broader equity market.
But income-seeking investors should be careful where they choose to put their money, at least in the ever-expanding exchange-traded fund space, experts warn.
John Davi, founder and chief investment officer at Astoria Portfolio Advisors, told CNBC's "ETF Edge" on Monday that stocks and bonds with high dividend yields currently look "crowded, expensive [and] vulnerable" to him.
"I think what a lot of investors do is they say, 'OK, I like this high-dividend-yield ETF. It yields 3, 4%.' That's great, but just keep in mind that that carries a lot of risk," the ETF investor said.
Contrast that with the U.S. 10-year Treasury, which Davi cast as a "risk-free asset," and ETFs with large dividend yields look riskier and riskier, he said.
Davi flagged three high-dividend ETFs that he would outright avoid: the iShares Core High Dividend ETF (HDV), the Vanguard High Dividend Yield Index Fund ETF Shares (VYM), and the iShares Select Dividend ETF (DVY).
His reasoning? HDV's portfolio is 21% energy stocks, and energy is the worst-performing S&P 500 sector this year. VYM has 18% of its holdings in the banking subsector, another risky area with the Federal Reserve's next policy move still in question. DVY's portfolio is 40% banks and utilities, which could be at risk if the economic cycle turns lower.
"That's a lot of risk for me," Davi said. "What we use is DGRW from WisdomTree. This is more of a dividend growth, high-quality ETF, so it screens for companies with above-average [return on equity], [return on assets], and above-average earnings. And the idea there is that strong fundamentals can eventually lead to high dividend growth."
That's the WisdomTree U.S. Quality Dividend Growth Fund, which is up over 18% year to date and counts the stocks of Apple, Microsoft and Verizon among its top five holdings. Davi also liked emerging markets dividend play EDIV, the SPDR S&P Emerging Markets Dividend ETF, which is up a modest 3% this year.
Dave Nadig, managing director of ETF.com, also issued a warning on high-yielding ETFs.
"If you look at some of the funds that have very attractive headline yields right now, like the Global X Superdividend fund [ticker SDIV], yeah, that may have a 7 or 8% yield on it, but it's actually been a terrible performer," Nadig said in the same "ETF Edge" interview.
His suggestion was to approach the idea of dividends differently — not necessarily as a primary source of income, but as a way to add quality into a portfolio.
"Dividends as sort of a proxy for cash flow, as a proxy for quality, can make a lot of sense," Nadig said. "If you look at First Trust's Dividend fund [FVD] this year, ... it's got a headline yield of 3%, which is very market-like, yet it's beaten the S&P handily. So, I think thinking about dividends not so much for the coupon yield like you would for bonds, but as a proxy for quality, is probably a better play."
The First Trust Value Line Dividend Fund was Nadig's top pick for a 2019 dividend play. That ETF is up more than 20% for the year and counts industrial stock Fastenal and tobacco play Altria among its top holdings.
DGRW and FVD were both practically flat in Wednesday trading.