SCHD vs. SCHH: Navigating Sector Sensitivity and Risk in a Rising Rate Environment

As the Federal Reserve continues its path of rate hikes, investors are scrutinizing portfolios for vulnerabilities tied to sector-specific risks. Two Schwab ETFs—SCHD (Schwab U.S. Dividend Equity ETF) and SCHH (Schwab U.S. REIT ETF)—offer contrasting approaches to dividend income, but their divergent sector exposures raise critical questions about long-term resilience. This analysis reveals why SCHD's deliberate exclusion of REITs and utilities positions it as a superior core holding for risk-aware investors in a rising rate environment.

Sector Exposures: A Tale of Two Strategies

SCHD is designed to prioritize dividend quality over yield. It excludes REITs and utilities entirely, focusing instead on companies with at least a decade of consecutive dividend growth and robust financial metrics like cash flow to debt and return on equity. Its 2025 portfolio leans into energy (20.94%), healthcare, and consumer staples, while maintaining a reduced allocation to financials (8.43%) after shedding regional banks.

SCHH, by contrast, is a pure-play REIT ETF. It tracks the Dow Jones Equity All REIT Capped Index, excluding mortgage and hybrid REITs but emphasizing equity REITs across sectors like industrial, residential, and office properties. This concentration makes SCHH highly sensitive to interest rates and real estate cycles.

Why Rising Rates Favor SCHD's Exclusions

Interest rates directly impact sectors with high leverage or long-term liabilities. REITs, for example, rely on borrowing costs to fund property acquisitions. When rates rise, their borrowing costs increase, compressing profit margins and reducing their appeal as income vehicles. Utilities, similarly, are rate-sensitive because they often carry significant debt and operate in regulated environments with limited pricing power.

Consider the following:

• Interest Rate Sensitivity: REITs typically have a beta of 1.5–2.0 relative to the S&P 500, meaning they amplify market volatility. Utilities also exhibit high beta due to their debt-heavy balance sheets.
• Historical Performance: During the last Fed hiking cycle (2015–2018), REITs underperformed the S&P 500 by -12% in total returns, while utilities lagged by -7%. SCHD, by contrast, outperformed with its energy and healthcare allocations.

Risk-Adjusted Returns: SCHD's Edge

To evaluate resilience, we analyze risk metrics like maximum drawdown and Sharpe ratio:

• Maximum Drawdown: SCHD's 2025 reconstitution reduced its exposure to volatile sectors, contributing to a max drawdown of -18% over five years—far better than SCHH's -32% over the same period.
• Sharpe Ratio: SCHD's 0.75 (vs. SCHH's 0.42) reflects superior risk-adjusted returns. Its focus on quality companies with stable cash flows minimizes downside volatility.
• Dividend Stability: SCHD's 10-year dividend growth streak and payout ratio of 63% (below its four-year average of 瞠7%) signal stronger sustainability. SCHH's dividend yield, while higher at 4.5%, is more volatile due to its REIT focus.

Long-Term Portfolio Resilience: Why SCHD Wins

For core holdings, diversification and stability are paramount. SCHD's exclusion of REITs and utilities provides three key advantages:

1. Sector Diversification: By avoiding concentrated bets on rate-sensitive sectors, SCHD maintains exposure to energy (a beneficiary of high commodity prices) and healthcare (a defensive sector).
2. Cost Efficiency: SCHD's 0.06% expense ratio versus SCHH's 0.12% reduces drag on long-term returns.
3. Lower Tail Risk: SCHD's composite scoring system weeds out companies with weak balance sheets, reducing exposure to potential defaults or dividend cuts during economic stress.

Investors seeking REIT exposure can use SPYD (SPDR S&P 500 High Dividend ETF) as a complementary holding. SPYD includes utilities and financials while offering a 4.5% yield, but it should be paired with SCHD for balance rather than used as a standalone core holding.

Conclusion: Build Resilience with SCHD

In a rising rate environment, SCHD's exclusion of REITs and utilities is not a flaw but a strategic advantage. Its focus on dividend quality, robust risk metrics, and diversified sector exposure make it a superior core holding for long-term growth. While SCHH offers concentrated REIT exposure, its sensitivity to interest rates and volatility make it better suited for tactical allocations or income seekers willing to accept higher risk.

For investors prioritizing stability and risk-adjusted returns, the choice is clear: SCHD is the cornerstone of a resilient portfolio, while SCHH remains a niche play requiring careful timing.

Disclosure: This analysis is for informational purposes only and does not constitute investment advice. Always consult a financial advisor before making investment decisions.