The purpose of this article is to evaluate the Invesco S&P 500 High Dividend Low Volatility Portfolio ETF (SPHD) as an investment option as its current market price. While SPHD is only up modestly since I last recommended it, I feel the fund continues to offer an attractive value. The fund's dividend is growing slowly, but yields over 4%, which remains very competitive. With interest rates likely to decline by year-end, that high yield will continue to attract investor dollars. Furthermore, with trade disputes on every investor's mind, assets are likely to continue shifting to areas that are less sensitive to foreign sources. The Real Estate and Utilities sectors are two of the least sensitive, and happen to make up a large percentage of SPHD's portfolio. Finally, SPHD's underlying index has a strong track record of beating the broader market, and has noticeably out-performed the S&P 500 over the last ten years.
First, a little about SPHD. The fund's objective is to "seek investment results that generally correspond to the price and yield of the S&P 500 Low Volatility High Dividend Index, which is composed of 50 securities that historically have provided high dividend yields and low volatility". SPHD currently trades at $41.48 and yields 4.07% annually, based on the last twelve monthly distributions. I reviewed SPHD back in February, and recommended it as a high dividend option for 2019. In hindsight, the fund has performed moderately well, returning around 2% since that time, after accounting for distributions. While this return is fairly positive, it does under-perform the broader S&P 500 during the same time frame, so I wanted to reassess SPHD to see if it still makes sense to own going forward. I believe it does, and will explain why in detail below.
Real Estate & Utilities - Least Foreign Sensitive
During my prior review, I mentioned how I was drawn to SPHD primarily because of its high amount of Real Estate exposure, as well as Utilities. In hindsight, this has been a profitable play, as both of those sectors have performed relatively well so far this year. Looking at SPHD now, the top sector weightings are primarily the same, which makes sense since the fund does not re-balance until July. Real Estate and Utilities currently comprise 38.5% of total fund assets, as illustrated below:
With this in mind, I want to discuss why I feel this is a positive for the fund going forward. There are two primary reasons for this: foreign sensitivity and interest rates. Looking first at foreign sensitivity, I am becoming increasingly concerned with the on-going, and multiple, trade disputes the United States is currently involved in. The most important, in my view, is China, but there has also been some back and forth between European trading partners, as well as Mexico. While the threat of tariffs on Mexican imports has subsided over the past weekend due to an announced deal between the U.S. and Mexican governments, President Trump has stated he will re-consider the tariffs if he is not satisfied with future progress on border crossings. While the market has been very resilient in the face of these hurdles in the near-term, I do not expect all of these matters to be fully resolved for some time, and therefore expect market volatility over the coming months.
With this in mind, I recommending Real Estate and Utilities specifically because these sectors are traditionally less sensitive to foreign trade and, therefore, the on-going trade disputes. In fact, this thesis has been playing out perfectly over the past month, with Real Estate and Utilities being the only sectors to register positive returns from May 6 - June 6, as shown below:
As you can see, when trade tensions really started to heat up last month, cyclical areas such as Energy and Info Tech were under-performers, while defensive areas such as Consumer Staples, Real Estate, and Utilities all bucked the broader market trend.
A primary reason for this, aside from being more defensive in nature, is because these are areas that have less foreign exposure. This is important because a sector like Real Estate is not always defensive (think 2008-09), but is acting defensively now because the primary reason for the recent volatility is political trade tensions. This has caused investors to seek out sectors and companies that rely less on foreign trade, and obtain most of their revenues (and profits) from domestic consumers. The two sectors who obtain the least amount of total revenue from foreign services was, not surprisingly, Real Estate and Utilities. According to the Charles Schwab data, Real Estate and Utilities obtain 14% and 3% of total revenues from foreign sources, respectively. To put this in perspective, consider that Info Tech obtains almost 58% of revenue from foreign sources.
My takeaway from this is that if investors are concerned about on-going trade disputes, as I am, they may want to take shelter in the areas that are less trade sensitive. Undoubtedly, these sectors will probably lag if we get resolutions on trade in the short-term, but given the number of disputes currently open, I do not expect that to happen. SPHD, with its dual exposure to both Real Estate and Utilities, offers investors a way to play this thesis.
Potential For Lower Interest Rates
My second primary reason has to do with interest rates, specifically the current outlook. While interest rates have been low for some time, 2018 saw the Fed shift gears dramatically, by raising rates four times. While rates remained at historically low levels, investors began to rotate out of higher yielding sectors, such as Real Estate and Utilities, especially since the expectation was 1-2 more rate increases in 2019. However, as volatility hit the market late last year, the outlook became more dovish. In fact, back in February, the general consensus was that interest rates would finish 2019 where they began. Now, the outlook has shifted even more dramatically. Due to trade and global growth concerns, dovish sentiment is currently dominating the market. The futures market is now predicting between 2-3 rate cuts by year-end, according to data compiled by CME Group, illustrated in the chart below:
As you can see, investors have all but ruled out constant rates, and expect them to head markedly lower over the next six months. This means investors will want to lock in higher yields, whether in bonds or equities, now, before rates go any lower.
Again my takeaway is positive for SPHD. Locking in a 4% yield on current assets seems smart given this forecast. Furthermore, there is a good chance of price appreciation if the top underlying sectors do indeed perform well (which I believe will be in the case).
High Yield Makes Up For Low Growth
I now want to briefly discuss the fund's dividend, as that is another key reason for recommending SPHD. With a yield above 4%, I do believe SPHD will continue to attract investor interest, especially for the reasons described above. One point of concern, however, is that dividend growth has noticeably slowed in the short-term. While this was a positive attribute last year, the growth so far in 2019 has been very modest, as the chart below illustrates:
|Jan - May Distributions (2018)||Jan - May Distributions (2019)||YOY Growth Rate|
Source: Invesco (Calculations made by Author)
As you can see, there has not been much growth to speak up in the first half of the year, although that could change going forward. This tells me that investors need to be realistic about the future yield, and I would not expect it to move much higher than the low 4% mark (assuming constant share price).
With this in mind, I reiterate that SPHD remains a good dividend play, but primarily because yields offered elsewhere are currently not competitive. With rising equity prices and shrinking bond yields, not many funds, stocks, or treasuries offer yields near 4%, so SPHD should be on the radar for income-oriented investors. However, if interest rates defy the current consensus and head higher over the next 6-18 months, this 4% yield will not look nearly as attractive as it does now. With growth lacking, I am not as comfortable with SPHD as a way to combat rising interest rates, and would advise investors to remain cognizant of this reality going forward.
Index Beat The S&P 500 Over The Last Decade
A final point on SPHD has to do with the fund's underlying index, which is the S&P 500 Low Volatility High Dividend Index. With "low volatility" in the name, investors may be thinking they are buying in to a fund that is too defensive and will measurably under-perform during good times. While this would seem to make logical sense on the surface, the fact is that during the last ten years, this index has actually out-paced the broader S&P 500, and with less volatility. While this should happen during down markets, the past ten years has been a bull market, and yet the underlying index still out-performed by quite a bit, as shown below:
Source: S&P Global
My point here is not to say that this index, or SPHD, will continue to out-perform the S&P 500 indefinitely. Rather it is to show that while I view the fund as more defensive in nature, it clearly has holdings that were able to hold their own even during a booming stock market. This tells me SPHD is a good choice for a core, long-term holding. The high-yield and utilities exposure make it a great fund for dropping markets, but its cyclical sectors are weighted high enough to allow for out-performance during the good times as well.
Now that I have laid out why I am generally bullish on SPHD, I want to touch on the inherent risks in buying now. First, while I view the fund's heavy concentration to the Utilities and Real Estate sectors as a positive, that exposure could quickly turn against the fund if market conditions change. A primary concern would be interest rate risk. While the market seems to be expecting multiple rate cuts this year (benefiting higher yielding sectors), those are by no means guaranteed, and a lack of cuts could disproportionately hurt income-oriented investments. While the Fed has hinted at the potential for rate cuts, there has been nothing concrete to suggest a cut is imminent, and the market may be overestimating just how dovish the Fed is going to be. In fact, Goldman Sachs just came out with a research note today (6/10), reported by CNBC, indicating they believe the Fed will keep rates neutral for the reminder of 2019, which contradicts prevailing market sentiment. My point here is that defensive sectors have been performing well partly because of the interest rate outlook, so a broad change in that outlook could certainly have a negative effect.
Second, while I do view SPHD as a more defensive fund, it is still comprised entirely of equities, and is prone to large swings when the market is dropping. For example, at the end of last year, the market as a whole performed quite poorly, and SPHD was no exception. In fact, the fund lost over 15% of its value in a fairly short period of time, as illustrated below:
Source: Seeking Alpha
In fairness, SPHD did perform slightly better than the broader market during the November-December volatility. But my point here is that investors need to have realistic expectations about how this fund will perform in downtimes. While the holdings are defensive in nature, and the "low volatility" title suggests safety, the fund still carries plenty of downside risk, which is important for investors to be aware of.
SPHD continues to draw my interest, and I believe the forward outlook remains positive for the fund. With the market only a few percentage points off all-time highs, I would caution investors to be careful here, and not be greedy. Trade fears dominate news channels, and global growth remains a primary challenge for most economies. SPHD provides some safety from these developments, as the fund's top sectors obtain the vast majority of their revenue streams from domestic sources. This shields those companies, and SPHD as a whole, from some of the negative effects of trade disputes. Further, SPHD has the right formula to out-perform the broader market if equities do push higher, as we have seen over the past ten years. With a high yield that is still growing (albeit modestly), interest rates expected to decline, and sectors that are out-performing during trade-induced volatility, SPHD remains a solid investment choice. Therefore, I would recommend investors give this fund a serious look at this time.
Disclosure: I am/we are long SPHD. 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.