Combine Dividend Strategies With Ultra-Low Volatility Investing

| About: PowerShares S&P (SPLV)

Summary

Dividend investors crave income.

They also want extremely low volatility.

Today, we examine a strategy index which combines both.

ZOMMA's macro view is that unique intellectual property, based upon science rather than artistry, will drive investment performance in the future. Evidence-based strategy indices will eclipse hedge funds and traditional active management due to their transparency, liquidity, and low costs.

Today, we are examining another evidence-based strategy index which incorporates dividends and ultra-low volatility.

Here are the Ultra-Low Volatility Index's original rules:

  1. Buy the PowerShares S&P 500 Low Volatility Portfolio ETF (SPLV) with 80% of the dollar value of the portfolio.
  2. Buy the Direxion Daily 30-Year Treasury Bull 3x Shares ETF (TMF) with 20% of the dollar value of the portfolio.
  3. Rebalance annually to maintain the 80%/20% dollar value split between the positions.

Here are the results of the original index:

Click to enlarge

What can we do to incorporate dividend-based strategies and ultra-low volatility?

Here are the modified index's rules:

  1. Buy the iShares Select Dividend ETF (NYSEARCA:DVY) with 80% of the dollar value of the portfolio.
  2. Buy the Direxion Daily 30-Year Treasury Bull 3x Shares ETF with 20% of the dollar value of the portfolio.
  3. Rebalance annually to maintain the 80%/20% dollar value split between the positions.

Here are the results:

Click to enlarge

The DVY ETF is an extremely popular dividend ETF, which not only weighs stocks according to the dividend yield, but also screens for growing and sustainable dividends. We find that combining DVY with 3X leveraged long duration government bonds yields a splendid result, combining dividend growth with low volatility investing. This combination is especially useful to retirees and pension funds.

In addition, we find that the index rules can be applied to other popular dividend ETFs.

Here are the rules for another modified index:

  1. Buy the SPDR S&P Dividend ETF (NYSEARCA:SDY)with 80% of the dollar value of the portfolio.
  2. Buy the Direxion Daily 30-Year Treasury Bull 3x Shares ETF with 20% of the dollar value of the portfolio.
  3. Rebalance annually to maintain the 80%/20% dollar value split between the positions.

Here are the results:

Click to enlarge

According to ETF.com's summary:

SDY takes dividend sustainability screens to an extreme level, only including firms that have increased dividends for the past 20 years in its selection universe. The highest yielding firms are then weighted by dividend yield.

The SPDR S&P Dividend ETF tracks a yield-weighted index of 50 dividend-paying companies from the S&P 1500 Composite Index that have increased dividends for at least 20 consecutive years."

As we can see, combining SDY with TMF in our rule framework also yields an excellent result. In effect, the index combines high yield dividend aristocrats with our ultra-low volatility envelope.

As before, the combination of this ETF with 3X leveraged long duration U.S. government bonds gives us the maximum oomph from the bond allocation while allowing us to dedicate a lower dollar value to bonds and to keep a higher allocation in dividend stocks. The result is a return which exceeds the S&P 500, with far lower drawdowns within a multi-asset class framework.

Our Ultra-Low Volatility Indices perform well because of the advantages of low volatility investing. The low volatility anomaly has been exhaustively, empirically documented by Dr. Robert Haugen and others. Simply put, low volatility stocks tend to outperform high volatility stocks - totally contrary to the popular notion that higher risk denotes higher potential return.

When we combine the advantages of ultra-low volatility investing with dividend investing, we have a combination which mirrors the goals of pension funds and retirees.

These indices are not achieving long-term outperformance by rising more than the broader market during strong up years. The indices outperform across a cycle by adhering to the general pattern of underperforming during strong up years and outperforming during strong down years.

This leads to the happy result, which we have observed, of strong returns combined with low volatility.

Standard & Poor's reports that over a "10-year investment horizon, 82.14% of large-cap managers, 87.61% of mid-cap managers, and 88.42% of small-cap managers failed to outperform on a relative basis."

Clearly, the answer is not more reckless emotional decision making. The answer is the creation of quantitative indices which exploit market inefficiencies and combine diversification with ingenuity and discipline.

Growing, sustainable dividends combined with low volatility investing are two quantitative advantages which we exploit to our advantage.

It's important that investors understand that an index doesn't need to be a collection of 500 large companies. An index can be an index of ETPs chosen for their risk/reward, correlation, diversification, or dividend attributes. At ZOMMA, we call this a strategy index.

We believe that strategy index technology will beat most human investors over time. Rather than guessing about market direction, we are finding robust quantitative advantages to incorporate into index-based solutions.

The evidence is clear - multi-asset class indices can beat stock market performance across a cycle. And the mechanism is clearly defined quantitative insights into the long-term drivers of robust, sustainable outperformance.

Thanks for reading. We feature even more impressive strategy indices in our subscription service. If this post was useful to you, consider giving it a try.

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points, which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program, which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.