New Dividend Aristocrat ETF With A Whopping Big Yield

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About: Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF (KNG), Includes: NOBL
by: Kurtis Hemmerling
Summary

Dividend Aristocrats are desirable blue-chip dividend growers with a minimum 25 years of annual growth.

Current dividend yield might be too small for investors who need income.

Cboe Vest S&P 500 Dividend Aristocrat Target Income ETF solves these problems by targeting S&P 500 returns with a target income yield of the S&P 500 plus 3%.

There is no denying the popularity of dividend growth ETFs. The ProShares S&P 500 Dividend Aristocrats ETF (NOBL) has amassed almost $3.5 billion in roughly 4.5 years. The S&P 500 Dividend Aristocrat universe is a popular way to get large-cap exposure with stocks which have a long history (at least 25 years) of consecutive annual dividend increases. Investors also appreciate the higher returns of ETFs which mirror the index (NOBL) with lower volatility since inception.

But some investors have a problem with the Dividend Aristocrats ETF. The dividend yield is too low. The distribution yield was a measly 1.58%. You can see the problem in the chart below as the SEC 30-day yield is only at 2%.

NOBL ETF Dividend Aristocrats S&P 500 Yield

What if your income needs are greater than that? I realize that if you buy and hold for the next 10 years, that the income stream will also grow. But suppose that you need roughly 3-4% today. How can you still invest in the S&P 500 Dividend Aristocrat universe while meeting your income needs?

Dividend Growth Investments

Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF (BATS:KNG)

The Cboe Vest S&P 500 Dividend Aristocrat Target Income ETF has the goal of delivering an income yield which is 3% higher than the S&P 500 index. As a reference, this is a historical dividend yield chart for the S&P 500 compliments of YCharts.

S&P 500 Dividend Yield Chart

This would put the current income target at 4.89%. How is this achieved? With the use of covered call options.

How Covered Calls Can Boost Income Beyond Dividend Growth

We will use the example of AbbVie (ABBV).

  • Current share price is $93.00.
  • Selling a call option one month out with a $93.00 strike price generates a $3.45 premium.
  • This represents a potential annual income yield of 44% if premiums remained this high.
  • Dividend yield is 4%.

Does this mean we give up 100% of our potential for share price returns? Should we expect a distribution of 20-50% based on the above example of AbbVie? The following Q&A should answer some of those questions.

Questions On S&P 500 Dividend Aristocrat Target Income ETF

This leads to many questions.

When looking at the example of AbbVie, shouldn’t the income yield be much higher for KNG?

No. The fund sets a target of 3%. They only write options on a portion of the fund's value. This is referred to as the ‘percentage overwrite’ which is currently at 9.57%. As regards to AbbVie, the fund currently holds 1,140 shares and has written 1 contract on it (1 contract = 100 shares). This would translate into a combined annualized yield (dividends + options) of less than 8%. Of course, other holdings will have different dividends and implied volatility, so that when averaged, the distribution yield will be the S&P 500 yield plus 3%.

Doesn’t this limit my upside potential? Do I get any capital growth?

Yes and yes. It does limit your upside potential somewhat. The prospectus limits the ‘percentage overwrite’ at 20% and it is currently less than 10%. This means that you are currently trading one-tenth of your upside gain for additional income. If the stocks go up 10%, you would get 9% (at the current overwrite rate) in exchange for the additional income (S&P 500 + 3%).

Can I do this strategy myself?

Of course. You can write options on your own basket of stocks and do exactly the same thing… if you have the time and the desire. You should also have a sizable amount of capital or else transaction fees will eat you up and it will also be very difficult to manage.

Let’s look at the math. One options contract represents 100 shares. So if you wanted to write options on 10% of each position, you would need to buy 1,000 shares in each stock. You would need almost $120K to buy one position in Automatic Data Processing (ADP). The weighting of each stock would be all over the place so you would need even more than that for an equal-weight portfolio.

Of course, you could simply write call options on one-tenth or one-fifth of your portfolio. If you owned 10 Dividend Aristocrat stocks, you could write options on the entire value of just one or two stocks. You would be taking on more stock specific risk, though. It would be unfortunate if the two stocks you randomly chose to write options on were the ones with the largest price gains. But this would be a viable alternative to owning the ETF.

What about the expense ratio?

The expense ratio is 0.75%. This makes me a little sad because everything else about this fund gets two big thumbs up. I find the expense ratio a bit on the high side. That being said, it would be very time consuming and difficult to emulate this exact approach unless you had a huge chunk of cash to invest. Therefore, they have you over a barrel if you want this type of strategy. The expense ratio is not unreasonable, just a bit beyond my comfort zone.

Are there any other ways to get higher yields in the S&P 500 Dividend Aristocrat universe?

Sort of, although imperfectly. There are a little over a dozen S&P 500 Aristocrats (NOBL) which have a dividend yield of at least 3%. An equal-weight portfolio of these stocks would yield 3.7%. The downside is that you would be taking on a lot more stock specific risk and higher volatility.

Another option is to look for S&P 500 high dividend funds that have high overlap with dividend growth stocks (but not necessarily Aristocrats). The AAM S&P 500 High Dividend Value ETF (SPDV) had a yield ranging from 3.5%-4% and it has roughly a 70% overlap with dividend growth stocks which have a minimum of 5 years of consecutive annual dividend increases. That might provide you with the right blend of market-cap, yield and dividend growth, although this deviates from the pure Aristocrat strategy.

I know the ETF is new, but can you show the hypothetical performance of the index versus the S&P 500?

SPATI Dividend S&P 500 Index for Aristocrats and Covered Calls

What are the holdings of the Cboe Vest S&P 500 Dividend Aristocrat Target Income ETF?

StockTicker

SecurityName

Weightings

(ABBV)

ABBVIE INC.

1.75%

(ABT)

ABBOTT LABS

1.92%

(ADM)

ARCHER DANIELS MIDLAND CO.

2.14%

(ADP)

AUTOMATIC DATA PROCESSING INC. COM

1.95%

(AFL)

AFLAC INC.

2.07%

(AOS)

SMITH A O

1.95%

(APD)

AIR PRODS & CHEMS INC.

1.94%

(BDX)

BECTON DICKINSON & CO.

1.97%

(BEN)

FRANKLIN RES INC.

1.49%

(BF.B)

BROWN FORMAN CORP.

1.98%

(CAH)

CARDINAL HEALTH INC.

1.67%

(CINF)

CINCINNATI FINL CORP.

1.96%

(CL)

COLGATE PALMOLIVE CO.

1.75%

(CLX)

CLOROX CO DEL

1.61%

(CTAS)

CINTAS CORP.

2.09%

(CVX)

CHEVRON CORP. NEW

1.87%

(DOV)

DOVER CORP.

1.85%

(ECL)

ECOLAB INC.

2.16%

(ED)

CONSOLIDATED EDISON INC.

1.98%

(EMR)

EMERSON ELEC CO.

1.95%

(FRT)

FEDERAL REALTY INVT TR

1.81%

(GD)

GENERAL DYNAMICS CORP.

2.03%

(GPC)

GENUINE PARTS CO.

1.66%

(GWW)

GRAINGER W W INC.

2.12%

(HRL)

HORMEL FOODS CORP.

2.06%

(ITW)

ILLINOIS TOOL WKS INC.

1.82%

(JNJ)

JOHNSON & JOHNSON

1.79%

(KMB)

KIMBERLY CLARK CORP.

1.69%

(KO)

COCA COLA CO.

1.85%

(LEG)

LEGGETT & PLATT INC.

1.83%

(LOW)

LOWES COS INC.

1.57%

(MCD)

MCDONALDS CORP.

1.81%

(MDT)

MEDTRONIC PLC

1.87%

(MKC)

MCCORMICK & CO. INC.

2.06%

(MMM)

3M CO.

1.76%

(NUE)

NUCOR CORP.

1.85%

(PEP)

PEPSICO INC.

1.70%

(PG)

PROCTER AND GAMBLE CO.

1.67%

(PNR)

PENTAIR PLC

1.91%

(PPG)

PPG INDS INC.

1.84%

(PX)

PRAXAIR INC.

1.88%

(ROP)

ROPER TECHNOLOGIES INC.

2.03%

(SHW)

SHERWIN WILLIAMS CO.

1.83%

(SPGI)

S&P Global Inc.

2.10%

(SWK)

STANLEY BLACK & DECKER INC.

1.69%

(SYY)

SYSCO CORP.

1.92%

(T)

AT&T INC.

1.88%

(TGT)

TARGET CORP.

1.83%

(TROW)

PRICE T. ROWE GROUP INC.

1.85%

(VFC)

V F CORP.

1.93%

(WBA)

WALGREENS BOOTS ALLIANCE INC. COM

1.66%

(WMT)

WALMART INC.

1.66%

(XOM)

EXXON MOBIL CORP.

1.80%

Summary

Writing covered call options on a small portion of the Dividend Aristocrat universe is an excellent way to retain the lion's share of your upside potential while juicing your cash flow payout.

Cboe Vest S&P 500 Dividend Aristocrat Target Income ETF will write options on up to a maximum of 20% of the fund’s value in order to achieve the S&P 500 dividend yield plus 3%. This makes it a very attractive fund for dividend growth investors who want high-quality stocks as a defense but who also rely on their investments to provide income beyond the current dividend yield.

This fund gets an A-. I would have given it an A+ if the expense ratio was lower.

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.