The Dividend Aristocrats And Maximum Drawdowns

| About: ProShares S&P (NOBL)


The Dividend Aristocrats, companies that have a greater than 25-yr history of paying increasing dividends, have outperformed the broader market over time.

Given the large Income Investing community on Seeking Alpha, this strategy has been widely debated and discussed and is popular amongst readers.

This article tries to build on that conversation by calculating the maximum drawdown of the Dividend Aristocrat strategy and discussing performance in weak markets.

I have written a number of articles about the Dividend Aristocrats, and how stocks that have paid increasing levels of dividends through multiple business cycles have produced higher absolute and risk-adjusted returns than the broader market over time. This article compares the drawdown this dividend growth investing strategy relative to the broader market, as proxied by the S&P 500 (NYSEARCA:SPY).

In addition to the aforementioned bellwether S&P 500 Index, Standard & Poor's produces the S&P 500 Dividend Aristocrats Index. (Please see linked microsite for more information.) This index, which is replicated by the ProShares S&P 500 Dividend Aristocrats ETF (BATS:NOBL), measures the performance of equal weighted holdings of S&P 500 constituents that have followed a policy of increasing dividends every year for at least 25 consecutive years. To put this into perspective, the average S&P 500 constituent now stays in the index for an average of only eighteen years, so the list of companies who have had the discipline and financial wherewithal to pay increasing dividends for an even longer period is necessarily short at 56 companies (10.3% of the index). Paying increasing levels of dividends through multiple business cycles is a relatively unique trait in corporate America, and this article seeks to measure the relative performance of this basket of steady dividend payers in the worst market environments. A list of the current constituents with some financial detail is appended at the end of this article for reference.

The returns of the S&P 500 Dividend Aristocrat Index and the S&P 500 Index since 1990 are compared below. At average annual outperformance of 2.62% per annum since 1990, the alpha generated by this strategy is robust.

Source: Standard & Poor's, Bloomberg

A tilt towards the Dividend Aristocrats was one of my five strategies for outperformance for buy-and-hold investors. This strategy has historically outperformed in part because it suffers lower drawdowns in tough market environments, but captures most of the upside in bull markets, which is demonstrable in the graph above. Lower drawdowns for high quality strategies is consistent with the recent article I published on the alpha-generative nature of low volatility stocks being driven by outperformance in down markets.

Using data from the S&P 500 Dividend Aristocrats Index, I have captured maximum drawdowns over various time horizons and compared these drawdowns to those of the S&P 500 Index below:

Source: Standard & Poor's, Bloomberg

Unsurprisingly, the worst drawdowns for the Dividend Aristocrats and the broader equity market overlapped during the financial crisis. On average, the drawdown for the Dividend Aristocrats was lower than that of the broader market. However, the drawdowns were lower in the Low Volatility Index (replicated by SPLV), discussed in a previous article. Over ten-year periods, the Dividend Aristocrats strategy have always produced positive returns, but this is an admittedly short dataset (1990-current), covering just three business cycle troughs.

Another way to demonstrate the outperformance of the Dividend Aristocrats in down markets has been the relative outperformance in years where the S&P 500 has produced a negative return. In each of the down years for the market over the last twenty-five years (2000-2002 and 2008), the Dividend Aristocrats have outperformed the S&P 500 by over ten percent in each year.

Source: Standard & Poor's, Bloomberg

I hope this article demonstrates the historical outperformance of the Dividend Aristocrats in down markets for Seeking Alpha readers.

Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon.

Appendix: List of Dividend Aristocrats

Source: Standard & Poor's, Bloomberg

Disclosure: The author is long NOBL, SPY, SPLV.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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