In a series of articles earlier this year (I, II, III), I examined eight dividend-oriented ETFs, hoping to find one that comes close to replicating what I do as a dividend growth investor. I looked under the hoods of some of the heavyweights in the dividend ETF space from several providers, including
- iShares Dow Jones Select Dividend Index (DVY, with over $10 B in assets)
- Vanguard Dividend Appreciation ETF (VIG, with over $13 B in assets)
- SPDR S&P Dividend ETF (SDY, over $9 B in assets)
I was very disappointed in what I found. My conclusions included the following:
- Few real dividend growth portfolios have current yields under 3.5%, while all of the eight ETFs I looked at had 12-month yields less than 3.5%.
- All of the ETFs I looked at suffered dividend declines in 2009, while most actual dividend growth investors enjoyed income increases that year.
- I found no dividend ETF that could be used as a proxy for dividend growth investing when making comparisons to other stock investment strategies.
- Individual, careful stock selection (including due diligence on company fundamentals) beats shotgun approaches based on dividend characteristics only.
- The flexibility to react to events as they happen (such as dividend cuts) beats annual portfolio reconstitution.
I also concluded that the ETF companies don't "get it" about dividend growth investing. On the websites I examined, performance was presented primarily or exclusively in terms of total returns. While distributions were dutifully reported, none of them highlighted dividend returns or the growth in their distributions. None spoke at length about the pros and cons of dividend growth investing during your accumulation years nor during retirement.
A couple of months later, in "An Open Letter to the ETF Industry: Create a Better Dividend Growth Product," I appealed to the ETF industry.
I am happy enough being an individual dividend growth investor myself, and I don't personally need a good dividend growth ETF at the moment. But many other investors could use such a product. And some day I will die. I would like to be able to tell my wife, who is not very interested in investing, to "just put it into XXX." But a suitable XXX does not exist.
Instead of a good dividend growth investment product, …we get products with weird, unexpected flaws:
- "Dividend" ETFs that do not appear to have a goal of maximizing and growing dividends, despite their names. Some of them report only on total returns, despite their apparent principal appeal to income-seeking investors.
- ETFs that do not react to red flags such as dividend cuts.
- Lousy yields.
- Sorry dividend growth rates and yields on cost.
- Distributions that have been cut from the prior year rather than showing steady year-over-year increases.
- Annual reconstitution of the stocks held, therefore an inability to react to dividend events that happen in the middle of the year.
- Oddly high volatility.
You guys can do better than that!
I outlined a process by which I thought that a better dividend growth ETF could be created that creates growing income streams of meaningful size over time through investments in common stocks, REITs, and MLPs. I based my proposal on a new index, BDDGX, which I humbly described as The Best Damn Dividend Growth Index Ever.
After that article was published, I stopped searching for a decent dividend growth ETF, but a couple have since come to my attention that may be better examples of what the ETF makers could do if they tried. Let's take a look at them.
PowerShares S&P 500 High Dividend Portfolio (SPHD)
Website: Click here to see the fund's own website.
Fund Family: Invesco PowerShares. According to their Web site, PowerShares "is anchored on a vision of delivering investment performance through the benefit-rich ETF structure…. Prior to Invesco PowerShares' inception, ETFs had been based largely on passive benchmark indexes that were designed to measure the market, but were never truly intended to serve as the basis for investment. PowerShares Dynamic ETFs replicate a rules-based Intellidex, which quantitatively chooses stocks for their capital appreciation potential, evaluating and selecting stocks based on multiple valuation criteria, rather than simply by market cap alone."
Year Introduced: 2012 (SPHD just started trading a week ago)
Net Assets: $3.8 Million
12-Month Yield: Not yet calculable. In a recent article, Morningstar estimated the yield as about 4.5%.
Morningstar Category: Large Value (category definitions).
Fund Summary: Seeks investment results that generally correspond (before fees and expenses) to the price and yield of the S&P 500 Low Volatility High Dividend Index. The fund generally will invest at least 90% of its total assets in common stocks that comprise the underlying index, which is compiled, maintained, and calculated by S&P. The index is composed of 50 securities traded on the S&P 500 that historically have provided high dividend yields and low volatility. The fund is rebalanced and reconstituted bi-annually.
Annual Expense Ratio: 0.30%, which Morningstar states "is a very reasonable price tag for this kind of fund."
Total Stock Holdings: 50. According to the prospectus, S&P first selects the 75 highest yielding securities from the S&P 500, then takes the 50 of those with the lowest volatility over the past 12 months. No sector is allowed to contribute more than 10 stocks to the index. Stocks are weighted by dividend yield, so the highest yielders get the highest weight. Individual stocks are capped at 3.0% of the total, and sectors are capped at 25%.
Top 10 holdings (26.4% of total assets):
- Pitney-Bowes (PBI)
- Windstream (WIN)
- CenturyLink (CTL)
- Health Care REIT (HCN)
- People's United Financial (PBCT)
- Lilly (LLY)
- Pepco (POM)
- PPL (PPL)
- Exelon (EXC)
- American Electric Power (AEP)
The fund's top sector weightings are utilities (22%), consumer staples (16%), and financials (13%).
Total performance: Not yet calculable for any meaningful time-frame.
Distribution performance: No distributions have been made yet. SPHD plans to make monthly distributions of income and annual distributions of net realized capital gains. Distributions can be reinvested through your brokerage; that is not done within the fund itself.
Review/rebalance cycle: The index will be rebalanced at the end of each January and July. As with other S&P indexes based on the S&P 500, if a security is removed from the S&P 500, it is also removed from the sub-index immediately.
Yield on Cost Performance after 4 Years: Not yet calculable.
Comments and Observations:
SPHD is fairly concentrated at 50 stocks, although that is a typical size for many dividend-growth portfolios. The caps on individual holding size and sector size will likely produce a fairly diversified portfolio. That said, restricting holdings to stocks in the S&P 500 guarantees that all stocks will be large cap, a distinct disadvantage in my opinion, as many great dividend-growth securities are smaller. The weighting by yield all but assures that a few companies with dividends at risk will be included, those whose yields are high because the market has lost faith in their long-term business models.
With no operating history, there is little to base an investment decision on except how closely this fund's approach concurs with what you consider to be dividend growth investing. The semi-annual reconstitution (rather than annual) is a step in the right direction. But the inability to react to negative dividend events (such as selling in anticipation of or at the time of a dividend cut) is a huge drawback. The prospectus makes it clear that no stocks will be added or removed except at the semi-annual rebalance unless the stock is dropped from the S&P 500 itself. I cannot comment on performance as there is none to report yet.
If the eight "dividend" ETFs that I examined earlier this year got grades like D and F for replicating what dividend growth investors actually do, this one might rise to C minus or so.
Global X Super Dividend ETF (SDIV)
Fund Family: Global X Funds (a New York-based provider of exchange-traded funds)
Year Introduced: 2011 (June 8)
Net Assets: $153 M
12-Month Yield: 7.7%
Morningstar Category: World Stock (category definitions).
Fund Summary: The Global X SuperDividend ETF tracks an underlying index produced by Stuctured Solutions AG called the Solactive Global SuperDividend Index that tracks the
price movements in shares of international companies with a high dividend yield. The index started with 100 companies in June, 2011. Diversification comes from the 100-security size of the portfolio, multiple industries, and multiple countries. The index provider applies filters to exclude companies they determine may be likely to reduce their dividends in the near future (be still my heart). Furthermore, all companies are reviewed on a quarterly basis and will be removed from the index if they have cut their dividend (OMG). The index provider determines the relative weightings of the securities in the index; the holdings appear to be nearly equal-weighted. The fund's holdings are centered in the mid-cap value range of the Morningstar style box. About 36% of the holdings are based in the USA, with Australia at 24%, UK at 9%, and Singapore and Canada at about 6% each. The fund is heavily invested in REITs at about 21% of the portfolio. Other top sectors are telecommunications (18%), financials (18%), and consumer discretionary (11%). Around 60% of the dividends are qualified. Since inception through September 5, 2012, the ETF had a beta of 0.94 relative to the S&P 500 Index.
Annual Expense Ratio: 0.58%. According to an article in ETF Trends, in September the expense ratio was lowered to 0.58% from 1.14% after the fund jettisoned business development companies from the portfolio.
Total Stock Holdings: 96 (probably will return to 100 at the next quarterly review)
Top 10 holdings (13.4% of total assets):
- Provident Financial (UK)
- Navitas (Australia)
- Maple Tree Logistics (Singapore)
- Invesco Mortgage Capital (USA)
- KGHM Polska Miesk (Poland)
- Standard Life (UK)
- Starhub (Singapore)
- Suntec REIT (Singapore)
- PDL BioPharma
- Ascendas REIT (Singapore)
Total performance: Begun in 2011. Up 12% YTD, up 11% in the past year, but down 1.5% since inception (June 8, 2011).
Distribution performance: Monthly distributions. They are not smoothed, the fund pays out all of the income it receives each month net of the management fee. As a result, the dividend fluctuates on a monthly basis, particularly at quarter- and year-end. Distributions so far have varied by a factor of more than 2x. Dividends received by the fund are net of foreign tax withholding. Dividends are not automatically reinvested by the fund, but that may be arranged through your broker. In 2011 (a partial year), total distributions (all income) were $0.9788. This year so far, distributions have totaled $1.184. It is too early to get a handle on dividend growth for this fund, as there are not yet two full years to compare to each other.
Review/Rebalance cycle: Quarterly. It took some digging into Structured Solutions documents to get more information about their approach to the underlying index. I found the following from a Guideline document at Structured Solutions (pdf):
- On the Selection Days (five days before the annual Adjustment Day), Structured Solutions provides an index committee with "the Selection Pool." The pool is made up of companies that have a dividend yield > 6% and < 20%, or > 3% for companies that currently are in the index. Companies must have a "dividend forecast [that] is at least stable, i.e. there is no official announcement…that dividend payments will be cancelled or significantly reduced in the future. No Closed End Fund, Business Development Companies (BDCS), Partnership (both Qualified Publicly Traded Partnership and non-qualified Partnership) or Trust" is placed in the selection pool.
- To determine the index's composition, the companies in the selection pool are ranked in descending order according to their trailing 12-month dividend yield. The 100 companies with the largest dividend yield on that day are then chosen as index components.
- On the annual Adjustment Day (last day in February), if a company is included in the selection pool, it is only removed from the index if its dividend yield is not in the top 200 of the selection pool. In this case, the company with the largest dividend yield that is currently not in the index is chosen as replacement.
- Once a quarter (last trading days in May, August and November), the index components are screened for dividend cuts or an overall negative outlook concerning the companies' dividend policy. Companies may be excluded on these quarterly reviews and will be replaced with the top ranked company from the selection pool that is currently not in the index, given the same weight as the member being deleted.
- If a company included in the index is removed from the Index between two adjustment days due to an "Extraordinary Event," if necessary, the committee shall designate a successor. "Extraordinary Event" is defined as a merger, a takeover bid, delisting, the nationalization of a company, or insolvency. Notice that a dividend cut is not listed as an extraordinary event. That would appear to be why a company that cuts its dividend is not removed immediately rather than waiting for the next quarterly review.
Yield on Cost Performance after 4 Years: Not old enough to be meaningful yet.
Comments and Observations:
In terms of portfolio management, I found more to like about this fund than any other that I have examined. Its quarterly review schedule sets it apart, as does its efforts to react to certain events. It tosses out companies that cut their dividends, although it waits until the next quarterly review to do so. The quarterly reviews and the idea of retaining companies (once in) that would no longer qualify for initial selection (within limits) are similar to how many dividend growth investors manage their portfolios.
The initial pool of companies, with its 6% minimum yield requirement, did not thrill me (I believe that is too high and leads directly to the abundance of REITs), nor did the exclusion of MLPs. There is no emphasis placed on dividend growth, just on high yields. As usual, the company website places no emphasis on the dividend returns of the fund (what distribution information I could find came from Morningstar).
The international exposure is attractive, and I imagine that some investors would find it very attractive. Overall, I give this fund a C+ on its approximation of what dividend growth investors do. It is the first fund I have examined that I might personally consider to invest in under a dividend growth strategy. Currently there is not enough of a track record to support such a move.