Vanguard Dividend Appreciation ETF: A Different Approach To Dividends
- VIG is a widely diversified, dividend growth-oriented ETF focused on large-cap equities.
- The fund targets firms with histories of strong dividend growth.
- Investors should consider VIG as a core holding due to experienced management, low fees, and strong performance.
The Vanguard Dividend Appreciation ETF (NYSEARCA:VIG) is a popular, income growth-oriented ETF that has provided shareholders an increasing stream of dividend distributions. We believe income-seeking investors should consider VIG as a core portfolio holding as the economic outlook continues to remain strong.
ETFs offer a simple, tax-efficient mechanism to access broad swaths of the market. ETFs have gained popularity on account of simple transactions, low fees, and market-linked performance. VIG is passively managed and tracks the performance of the S&P U.S. Dividend Growers Index, comprised of common stocks that have increased dividends annually for at least ten years. Interestingly, the strategy excludes the top 25% highest-yielding companies from the index. This point likely avoids yield traps. According to S&P Global, VIG is the only ETF which is linked to this specific index.
Source: S&P Global
The index includes 268 individual holdings with a mean market cap of approximately $50 billion. The index includes a wide range of market capitalizations with the largest being $2.48 trillion and the smallest being $400 million. The index is somewhat top-heavy with the largest position representing 5% and the top ten representing nearly 31% of the whole index.
VIG is simple and effective in its execution, offering investors an opportunity to diversify across capitalizations focusing on high-quality equities. The fund achieves a slightly higher dividend yield relative to traditional index funds such as the SPDR S&P 500 ETF (SPY), despite large portfolio overlaps. As it stands today, VIG's current yield of 1.58% does not offer a better yield than traditional income producers such as REITs and fixed income, however, the growth potential is where VIG truly shines.
Let's examine the fund and understand where VIG fits in the ETF ecosystem.
VIG is a passively managed ETF linked to the S&P U.S. Dividend Growers Index. The fund is large with nearly $78 billion in total assets under management. The portfolio includes 268 holdings diversified across a variety of industries. The fund mandates that each holding pay a dividend which has a history of growth, consistent with the overall objective of income. It's worth noting that the fund has no foreign holdings and a turnover rate of approximately 14%.
Sector allocations are widespread and consistent with traditional income-producing assets. The portfolio's largest allocation is industrials (21.1%) followed closely by consumer discretionary (15.9%). The portfolio excludes a real estate allocation altogether, which may ease investors' fears of rising interest rates. Additionally, the fund has a very small allocation to utilities (3.90%) which should appease investors for a similar reason. Should investors seek exposure to real assets, VNQ presents a viable complement.
The portfolio has maintained a balanced focus, blending equally between growth and value. As a result, the fund's constituents trade at a consistent valuation relative to broader equity indexes. The fund is currently trading at an aggregate PE ratio of 23.8x, which is more reasonable than the S&P 500 but still very rich.
The fund's top ten holdings include recognizable names with histories of robust performance and competitive advantages in their respective industries. Additionally, the fund is slightly more top-heavy compared to other index funds. VIG's top ten assets account for 30.5% of total portfolio holdings as compared to the S&P 500's 29.6% concentration.
In summary, VIG offers a best-in-class portfolio of blue-chip equities. The dividend growth focus inherently orients the portfolio towards an income focus. However, this is not reflected in the current yield so much as the total return benefits of growing distributions. As is consistent with other Vanguard funds, VIG commands an inexpensive management fee. The fund currently charges a 0.06% expense ratio, one of the cheapest on the market. In fact, Vanguard estimates that over the course of ten years, a $10,000 investment would incur a total of $142 in management fees.
Performance & Distribution
We have established why VIG has gained popularity as a dividend growth ETF. The outcome of the strategy has been a powerful combination of income and capital appreciation over all time horizons. VIG has performed in line with the global equities market, nearly pacing with the S&P 500 despite a differentiated portfolio. The fund has produced an annualized return of 13.8% over the past decade.
We want to highlight VIG's performance in terms of total return. The fund has outperformed other dividend-oriented funds by a substantial margin over long time frames. It is essential to understand the root of VIG's total performance. While the fund requires that holdings pay dividends, much of the focus is placed on growth as opposed to current yield. As a result, the fund targets firms with solid growth prospects which will not only increase dividends but also boost share prices accordingly. Current yield may be substantially lower than funds such as the Vanguard High Dividend Yield ETF (VYM) or the iShares Core High Dividend ETF (HDV), but total return dramatically outpaces, and the returns are more tax efficient.
So how successful has the dividend growth strategy been? One will notice, the dividend has grown tremendously over the past ten years. The fund's dividend growth has outpaced the S&P 500 over select time frames indicating the index is successful in its composition.
The fund has more than doubled its dividend since 2008, outpacing the S&P's growth by a substantial margin since the Great Financial Crisis. As reflected above, total return remains comparable meaning VIG is a reasonable choice for dividend-oriented investors who are not willing to sacrifice total return.
Income growth has become paramount in an inflationary environment. It appears inflation is sticking around as the current rate remains above 5.00%. The current rate remains higher than the past decade and individuals are feeling the impacts in everyday life. VIG's ability to meaningfully grow its income is an important part of protecting purchasing power. Should inflation remain high, traditional fixed income investors will feel pain given their fixed cash flow streams.
Source: US Inflation Data
VIG's success hinges largely on the fund's ability to grow its dividend at a rate that outpaces inflation. This becomes a tall order considering the current inflation rate, especially as compared to the past decade. However, VIG is one of few funds which is equipped to deliver this level of growth.
Source: Seeking Alpha
Since VIG's first full operating year in 2008, the fund has grown its distribution at a 7.72% compound annual growth rate, outpacing the current rate of inflation. Additionally, the dividend has outpaced the current rate of inflation for the past three years.
Broadly, the economy must remain well aligned with VIG's portfolio if investors hope the growth will continue. Recently, inflation and rising rates have not been the only risks plaguing investors' minds. The global supply chain continues to feel the impact of COVID-19 and the stresses thereafter. The situation may continue to be stressed given the introduction of the new Omicron variant. Should the world face more lockdowns, the fund will surely experience another period of deep stress.
We believe VYM is a core holding that investors should consider for a dividend approach that complements other portions of a portfolio. While the fund offers a spread over the S&P 500 dividend, the yield is still meager. Dividend-focused investors are often looking for current yield which can cover living expenses. VIG most likely does not fit these criteria given that its current yield is well under 2.00%. Despite being compensated by total return potential, the lack of current income airs a difficult question. What kind of investor should focus on VIG? This question is tough to tackle given total return investors who are willing to take equity risk can utilize the S&P 500 or other funds which have performed equally or better than VIG.
The logical answer would be income-seeking investors given VIG offers a yield superior to SPY and QQQ. However, shareholders looking for immediate yield have other options which offer comparable levels of long-term growth with superior current yields. For example, VYM generates a current yield which is nearly double VIG, while growing its distribution comparably.
Investors are left in a tough position. VIG executed its strategy flawlessly, delivering shareholder returns by identically replicating its underlying index. The fund is obviously a great performer and has delivered reliable returns with a growing distribution for shareholders to enjoy. Investors seeking current yield and growth may find a more attractive option elsewhere. Let's examine a blended approach of two popular low-cost ETFs from Vanguard. Investors may benefit from a combination of Vanguard's High Dividend Yield fund and S&P 500 fund which have current yields of 1.28% and 2.82%, respectively. A combination will provide shareholders with a superior current yield, a superior blended growth rate, and superior total return at many allocation splits.
10-Yr Dividend Growth
10-Yr Annualized Return
Source: Author Using Data From Vanguard
VIG is a strong performer with a solid value proposition given the management team and industry-leading expense ratio. The fund offers exposure to widely diversified dividend-paying domestic equities. The fund's passive management provides an index-linked approach which excludes the potential for outperformance when compared to active rivals. The ETF is scalable, transparent, and convenient with a reliable stream of dividends. The results are a popular ETF with a stable history. Despite being overshadowed by other available options, the fund remains a viable candidate for investors looking for simplicity.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of VOO, VYM either through stock ownership, options, or other derivatives. 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.
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