IDIV: Dividend Futures ETF, No Compelling Investment Thesis, Sell

Summary

• A reader and subscriber asked for my thoughts on IDIV.
• IDIV is a dividend futures ETF, whose returns are strongly dependent on S&P 500 dividend growth rates.
• IDIV's expected returns are quite low, and the fund has few other benefits.
• This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »

DNY59/E+ via Getty Images

Author's note: This article was released to CEF/ETF Income Laboratory members on September 22th, 2021.

The US Equity Cumulative Dividends Fund-Series 2027 (NYSEARCA:IDIV) is a dividend futures ETF. Long-term annual returns should roughly equal S&P 500 dividend growth minus 2.7%. S&P 500 dividends tend to grow at a 6.4% annual rate, so expect returns of about 3.7% moving forward. As the fund invests in dividend futures, there is no direct equity price exposure, but the fund's price does sometimes move with market sentiment.

IDIV's 13.1% distribution rate is much higher than the fund's expected returns because the fund self-liquidates about 10% of its holdings every year, and distributes the proceeds to investors. The fund's distribution rate is not indicative of underlying generation of income, capital gains, trading gains, or returns.

Although there is nothing significantly wrong or negative with the fund, I don't really see a viable investment thesis here. Expected returns are quite low, and are unlikely to go much higher, as S&P 500 dividend growth tends to be quite stable. IDIV might make sense for investors wishing to speculate on increased S&P 500 dividend growth, but this seems like an excessively niche trade. IDIV might make sense for investors bearish about most common asset classes for reasons of valuation, but bullish about economic and dividend growth, but this also seems like an excessively niche trade. I see no real reason to buy, and considering the fund's low expected returns, rate the fund a sell.

IDIV - Expected Returns Analysis

IDIV invests in dividend futures, derivative contracts with clearly specified characteristics, parameters, coupon, and capital payments. Dividend future returns are basically equivalent to S&P 500 dividend growth rates minus expenses. The fund's long-term returns are almost wholly dependent on these and a couple other factors. Specifically, and subject to certain simplifications and assumptions:

IDIV's long-term expected returns = S&P 500 dividend growth - futures contract price + 3.0Y treasury note rate - expense ratio = 6.35% - 2.27% + 0.49% - 0.87% = 3.7%

IDIV is basically the formula above, so let's go through each of the terms above. Doing so is essential to understanding how the fund works.

S&P 500 Dividend Growth

IDIV invests in dividend futures, which are derivatives contracts linked to the value of the S&P 500 Dividend Points Index (Annual). Said index measures the dividends paid by S&P 500 constituents year to date for the specified date. As an example, as of September 16, 2021, S&P 500 constituents have paid $44.62 in dividends, and so the index has a value of $44.62.

As the futures track the index, and as the index tracks the dividend payments, I'll simplify things and say the futures track the dividend payments directly.

(Source: S&P)

IDIV's dividend futures entitles the fund to all S&P 500 dividend payments during the year, at the end of the year. As an example, the S&P 500 paid $57.93 in dividends during 2020, and so the fund received $57.93 per dividend future in late 2020. The fund will receive the appropriate figure for 2021 in late 2021.

IDIV currently holds dividend futures for all years up to 2027:

(Source: IDIV Corporate Website)

Dividend future returns are, obviously, almost entirely dependent on dividends, with higher dividends meaning higher returns, and vice versa.

If S&P 500 dividend payments increase by $1, then dividend future and fund returns increase by $1.

If S&P 500 dividend payments increase by 1%, then dividend future and fund returns increase by 1%.

S&P 500 equity prices have no direct effect on the returns or prices of these futures.

S&P 500 dividends have grown at an annualized rate of 6.35% for the past few decades. Said figure should be your starting point when calculating IDIV's expected returns.

Futures Contract Price

IDIV's dividend futures are not free, but have to be bought from someone (a counterparty) for a predetermined contract price. Contract prices are generally set to be quite close to actual S&P 500 dividend payments. As an example, we have contract prices of $59.60 for 2021, and 2020 dividend payments of $57.93. The contract price is quite close to the actual dividend payments of the prior year, 2.88% higher to be more specific.

(Source: IDIV Corporate Website)

Lower contract prices are ideal, to minimize fund expenses / outlays, and to maximise the number of contracts bought

Profits should equal S&P 500 dividend payments minus futures contract price.

As an example, let's assume S&P 500 dividend payments for 2021 will equal $60. This would mean that IDIV paid $59.6 (contract price) for a security which will entitle the fund to $60.0 (S&P 500 dividend payment), for profits of $0.40 ($60.0 - $59.6).

Profits can also be expressed in percentage terms.

If S&P 500 dividend payments increase by 10%, and if contract prices are 2.3% higher than the prior year's dividend payments, then profits should roughly equal 7.7% (10% - 2.3%).

S&P 500 dividends tend to grow at an annual rate of 6.35%, dividend future contract prices are 2.27% higher, so expected returns are roughly equal to 4.08%.

It should be possible to determine a fair value contract price for most of these futures. Doing so is outside the scope of this article, but based on my (limited) options and derivatives knowledge, I believe that the 2.27% contract price premium paid by IDIV to be excessive. As such, and in my opinion, the fund is not a buy at these prices.

As an aside, contract prices do tend to move quite a bit, and these materially impact the fund, its expected returns, and investment thesis. I was originally much more bearish about the fund because contract prices were much, much higher as recently as a couple of days ago. Then markets went down due to fears of Chinese contagion, and IDIV's contract prices contracted to more reasonable levels. It is not trivially easy to calculate a 'buy' level for these contracts, but the fund might warrant a second look at a 1.0% contract price.

3.0Y Treasury Note Rate

When IDIV bought its dividend futures for a $59.6 contract price, it didn't actually wire the entire $59.6 to the counterparty. It wired a small amount of money, bought a very safe asset with the rest, generally treasury bills and the like, and pledged said asset as collateral for the dividend future. Importantly, IDIV receives all interest and coupon payments from these assets, and are an integral component of the fund's expected returns.

As per management data, IDIV's collateral consists of U.S. treasury notes with an average maturity date of 3 years.

As per U.S. treasury data, these securities have an average yield of 0.49%.

IDIV receives said 0.49% yield, which directly increases the fund's returns.

Expense Ratio

Finally, IDIV has an expense ratio of 0.87%. Quite high for an ETF, but reasonable for a fund focusing on such a niche strategy. Said expense ratio directly reduces shareholder returns.

IDIV - Expected Returns

Consider all the factors above, and we can say that:

IDIV's long-term expected returns = S&P 500 dividend growth - futures contract price + 3.0Y treasury note rate - expense ratio = 6.35% - 2.27% + 0.49% - 0.87% = 3.7%

IDIV's actual returns have been somewhat lower, at 2.9%.

(Source: ETF.com)

IDIV's actual returns were lower than expected as the coronavirus pandemic led to a drop in S&P 500 dividend payments, directly reducing fund returns. Remember, I'm using a 6.35% figure for S&P 500 dividend growth as this is the index's long-term average dividend growth. Actual dividend growth might materially differ from said long-term average, as has been the case these past few years.

Accounting for these issues in the formula, you get 3.0%-3.2% in expected annual returns for the fund, quite close to the fund's actual returns.

Point being, the formula is a reasonably accurate gauge of the fund's expected returns.

IDIV - Quick Distribution Analysis

IDIV currently yields 12.8%. Of this, roughly 10% comes from the fund partially self-liquidating itself every year.

This 10% is not reflective of the fund's underlying generation of income, capital gains, or returns, it is simply a consequence of the fund's structure, distribution and self-liquidation policy. The other 2.8% is (somewhat) reflective of the fund's income, capital gains, and returns.

Don't think of IDIV as a fund yielding 12.8%, think of it as a fund yielding 2.8% with a 10% ROC distribution. It is quite a bit more complicated than this, but this is a much more accurate reading of the fund than focusing on the 12.8% number.

IDIV - (Lack of) Investment Thesis

To summarize, IDIV's long-term returns should roughly equal S&P 500 dividend growth rates minus 2.7% moving forward.

IDIV also returns a significant portion of its value to shareholders every year. Most of the fund's distribution consists of this.

I don't really see an investment thesis here.

Expected returns, yields, and income are all quite low.

IDIV's expenses, 0.87%, are a significant portion of the fund's expected returns, about 3.7%. Expensive low-return funds are rarely good investment opportunities, as the low returns are just not worth the high expenses.

The fund's distribution looks quite high as it is mostly ROC. There is (almost) nothing behind the distributions: no income, capital gains, trading gains, etc. Distributions such as these are not beneficial for shareholders, and are not part of the fund's investment thesis.

There are no hedges of any kind here.

IDIV does make some amount of sense for investors wishing to speculate on higher dividend growth, but this seems an excessively niche trade. Investors don't need to speculate about dividend growth to generate income or beat the market, and I doubt most retail investors have any special knowledge or edge in this particular niche. I certainly can't tell you if IDIV's futures are significantly mispriced accounting for expected S&P 500 dividend growth rates. Perhaps they are. Perhaps dividend growth will skyrocket in the coming years and IDIV will significantly outperform. I see no evidence for this, but it is definitely possible, and perhaps some investors might wish to speculate on the possibility.

If I were a bit more optimistic or bullish about the fund, I would say it has the following investment thesis.

IDIV's futures are somewhat uncorrelated from equity and bond prices. Look back at the formula, and you'll see that equity prices, interest rates, or S&P 500 returns are nowhere to be seen. The fund should see some long-term returns, about 3.7% per year, even if equity prices collapsed and interest rates went up / bond prices went down. This isn't nothing, but it is not that much either.

In practice, although IDIV's long-term returns are uncorrelated with equity prices, short-term returns and prices are strongly correlated investor sentiment, which also drives equity prices. As an example, IDIV was down 28% during 1Q2020, the onset of the coronavirus pandemic, and the most recent downturn. IDIV significantly underperformed the S&P 500 during said time period.

Data by YCharts

Unclear what the investment thesis is for an investment which significantly underperforms during a recession, offers lackluster total shareholder returns, and will almost certainly underperform during a bull market.

IDIV - Risks

As should be clear from the article, IDIV is a complicated fund. There are tons of details which are somewhat important, but outside the scope of the article. A proper analysis of the fund and its holdings would include, at the very least, a more thorough look at how the fund would perform under different conditions (recessions, growth, etc.), futures contract prices and their determinants (are these good or bad prices considering prevailing interest rates, etc.), and of the different quantitative metrics affecting an investment (beta, convexity, etc.).

In my opinion and experience, complexity is rarely a benefit for investors. There are exceptions, but these are few and far between.

IDIV - Expert Opinion

Finally, I wanted to share a quick Twitter thread by Dr. Benn Eifert. Dr. Eifert is a cofounder of QVR advisors, a boutique investment firm focusing on options and volatility strategies. Dr. Eifert rarely analyzes specific funds, but he does analyse option strategies used by some of the more popular retail option funds, and I've always considered what he has to say when analyzing these option funds. Although he might not use these precise words, Dr. Eifert is not a fan of these dividend futures funds or securities, and would probably not buy them at these prices. I'm inclined to agree.

Conclusion - Strong Sell

IDIV is an excessively complicated, risky dividend futures ETF with low realized and expected yields, capital gains, and total returns. There is no viable investment thesis here, and the fund's complexity could result in unexpected, poor performance. As such, the fund is a sell.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.