Ben Fulton is the CEO of Elkhorn Securities. Elkhorn is a leading independent investment solutions firm pioneering innovative research-based financial products in a wide array of investment structures.
Ben Fulton's interview is below. My questions to him are in bold.
You have a very impressive background; it's quite an honor to have you on Sure Dividend. Please tell my audience a little about yourself and your experience in creating ETFs and investing in general.
I began my career in financial services over 30 years ago, transitioning from a CTA to product development at a number of Chicago-based firms. Prior to starting Elkhorn, I was Managing Director of Global ETFs at Invesco PowerShares, where we put together some of the most innovative and influential ETFs on the market today including the first fundamental -weighted, low volatility, commodity, and water ETFs.
Would you classify yourself as a dividend investor, a value investor, a contrarian, a quant, or something else entirely?
Something else entirely.
As someone who has been building products for several decades, my goal is to build thoughtful research-based products that provide investors differentiated exposure to what is already available in the market today.
Because strategies tend to have varying performance over a full business cycle, I like to keep an open mind with investing.
ELKU Currently Holds 159 Stocks. How Do You Determine the Approximate # of Securities to Hold in ELKU?
Most Dividend ETFs available today are backward looking, screening for companies that only have a high yield or strong dividend growth.
The Elkhorn FTSE RAFI U.S. Equity Income ETF replicates the FTSE RAFI™ U.S. Equity Income Index, employing a forward-looking approach that seeks to marry the need between quality and high-yielding companies.
Research Affiliates (the index provider) screens a universe of high-yield U.S. stocks, looking at stability of earnings, debt coverage ratios, and the absence of accounting red flags to comprise the index.A firm with declining profitability may not be able to maintain or grow dividends. A company with a poor or declining debt coverage ratio puts equity holders and their dividends at increased risk. Finally, poor accounting policies can overstate the financial stability of a company. This strategy is intended to avoid dividend surprises.
As a follow up question, what made you decide on a yield and value weighting scheme for ELKU as opposed to an equal weighting scheme?
Research Affiliates uses a combination of fundamentals and dividend yield (after screening for income stability), as opposed to just a dividend yield, market cap or equal weighting scheme. This approach tends to avoid large sector concentration bets and adds a quality component to the strategy.
How often is ELKU rebalanced?
Both ELKU and its index, the FTSE RAFI™ U.S. Equity Income Index, are rebalanced quarterly.
I'm very interested in the intersection of quantitative quality metrics and dividend stocks. What in your opinion are the most important quality metrics to screen or rank dividend stocks?
This is one of the main reasons we were drawn to the FTSE RAFI™ U.S. Equity Income Index as a prime ETF candidate.We don't tend to find many high yield dividend ETFs that screen for income sustainability.
Many dividend ETFs simply screen for the highest yielding stocks without considering whether these companies have the financial viability to maintain these dividends going forward. The need for high income within equities is an area we think will continue to be of high interest in the coming years.
Based on RAFI's research, screening out companies with declining earnings, poor ability to service debt or potential accounting flags is a great way for investors to ensure more stable and sustainable income stream.
What factors do you think are responsible for the excellent performance of 'quality' dividend indexes like the Dividend Aristocrats Index and the FTSE RAFI US Equity Income Index over the last decade?
Historically, dividends have made up a large portion of the equity markets' total return. With bond yields steadily moving lower since 2007, investors have increasingly used dividend-paying stocks in lieu of bonds for their income needs. Companies that offer both high income potential and financial stability will continue to appeal to investors.
Aside from ELKU, what ETFs do you think are most likely to outperform over the long-run?
Although we don't speculate on future ETF performance, we do think an area of the equity market that has been overlooked are strategies focused on long-term value creation. Companies successfully reinvesting for future growth seem to be forgotten as investors prefer more short-term shareholder returns, such as buybacks. Going forward, we think companies with an eye towards future growth may be well positioned.
Do you think rising interest rates will cause high yield dividend stocks to underperform the market if/when they occur?
That is a great question.We believe strategies that are chasing yield may suffer during periods of rising interest rates.
Although we don't know when or how sudden rates may rise, research has shown that while utilities tend to offer some of the highest dividend yields on the market, they also carry some of the highest interest rate risk. Given many high yield dividend ETFs are yield oriented, utilities can often make up a large piece of these strategies.
Here is where RAFI's use of income sustainability and fundamentals can result in a more diversified dividend strategy. Currently the FTSE RAFI™ U.S. Equity Income Index has 7.4% exposure to the utilities and telecom sectors compared to other high yielding equity strategies that have more than 37% exposure to these sectors.
If you could change one thing about the investing industry, what would it be?
We believe the industry needs more thoughtfully designed investment products.
What do you think is the future for ETFs in general?
We see a lot of opportunity in the fixed-income ETF space as investors look for more targeted ways to gain exposure to this area of the market. We also see opportunities for ETF issuers working with institutions and RIAs to develop unique strategies for their investors.