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Article Purpose
Welcome to the fourth edition of my monthly dividend and income ETF series, where I summarize key metrics for 76 ETFs across the U.S. dividend, income, and risk management categories. As an introduction for new readers, I started this series to make it easy for investors to find the best ETFs to suit their unique investment objectives. These are lengthy posts, but I've created the graphic below to give you an idea of what to expect each month.
I like to begin these articles by giving a full picture of the U.S. equity ETF market. The table below provides median performance metrics for the 38 categories in my database of 740 ETFs, and I have sorted the categories in descending order by their December 2021 returns.
Source: Created By Author Using Data From Portfolio Visualizer
As you can tell, dividend ETFs had a great month. ETFs in the Total Market Dividends and High Dividend Yield categories returned above 7.50%, while the Large-Cap category wasn't far behind with a median return of 6.53%. Related were strong performances in the Real Estate (9.46%) and Consumer Staples (9.79%) sectors. Real Estate was actually the second-best performing category in 2021, while Consumer Staples rushed to make up some long-lost ground. Its median 17.20% annual return was well behind the 28.74% the SPDR S&P 500 Index ETF (SPY) earned, but the biggest losers of the year were thematic ETFs. While funds like the First Trust Water ETF (NYSEARCA:FIW) beat the market, others, including the ARK Innovation ETF (ARKK), dropped over 23%.
Without oversimplifying things too much, I'd like to borrow a graph I created for my article titled VGT: Why A Tech-Led Crash Is Unlikely. The data from 1990-2020 merely confirms what all of us inherently know: unprofitable stocks have tremendous upside potential but just as much downside risk. On the other hand, profitable stocks are much less risky and better suited for long-term investors. For example, in 2020, unprofitable stocks, which you're more likely to find in ARKK, gained 79.31%, while profitable stocks gained only 15.10%. However, through November 2021, unprofitable were only up 2.21%, while profitable stocks gained 23.06%. And, given that value ETFs appeared to have outpaced growth stocks in December, that gap is likely even wider now.
Source: Created By Author Using Data From Kenneth R. French Data Library, Portfolios Formed On Earnings/Price
I also want to point out that those prominent peaks you see for unprofitable stocks never last long. At the height of the dot com bubble, unprofitable stocks gained 53% before swiftly falling 34.35% per year for the next three years. In 2009, when investors were optimistic after recovering from the Great Financial Crisis, unprofitable stocks gained 63% before eventually significantly underperforming by 20% two years later. The takeaway here is that if you're not looking to speculate with ETFs, look at the profitability of the holdings. Given the history, it's not much of a surprise to see speculative ETFs reverse course in 2021.
Now that we understand the defensive turn markets took last month, let's look closer at the performance of the seven categories that are the subjects of this monthly series.
Total Market Dividend ETFs
While many dividend ETFs draw from a large portion of the U.S. equity market, very few have less than 80% allocated to large caps. The reason is that most are market-cap-weighted, or some variation of it such as weighting by aggregate dividends, which takes into account outstanding shares. We have several mega-cap, dividend-paying stocks like Apple (AAPL) and Microsoft (MSFT) that still manage to earn high weights in dividend-focused funds despite their comparatively small yields. I've listed the four I could find below, including information on expenses, assets under management, yield, dividend growth, beta, and performance history.
Source: Created By Author Using Data From Seeking Alpha And Portfolio Visualizer
As I have in past reports, I reiterate that I do not suggest this approach to dividend investing. Fees are generally higher, and it's much easier to build a portfolio of ETFs with the exact allocations you desire for less cost. With that said, the JPMorgan U.S. Dividend ETF (JDIV) was the top performer in December, gaining 7.91%, making it the 7th-best dividend ETF in any category. Other than last month, however, it was flat since I reviewed it in April, though with the Index recently reconstituting, it's worth taking another look soon.
Large-Cap Dividend ETFs
In December, the best-performing dividend ETF was the Legg Mason Low Volatility High Dividend ETF (LVHD), which has a five-year beta of 0.76, a reasonably attractive 2.56% dividend yield, and a 7.65% five-year dividend growth rate. Recall how the low-volatility theme played out well in December, as it was the eighth-best-performing category. LVHD has a 27.35% allocation to the Consumer Staples sector, so that's the primary reason for the excellent performance. Another top-performing fund was the WisdomTree U.S. Dividend Growth ETF (DGRW). This ETF is weighted based on aggregate dividends so that you will have about 10% exposure to Apple and Microsoft. Given its relatively low yield and sector composition, I liken it to an S&P 500 alternative, as I wrote in my article from June.
Source: Created By Author Using Data From Seeking Alpha And Portfolio Visualizer
Two other market-like ETFs that performed well in December were the iShares Core Dividend Growth ETF (DGRO) and the Vanguard Dividend Appreciation ETF (VIG). Like DGRW, DGRO has a double-digit five-year annualized dividend growth rate, so it's great for jumpstarting a DGI portfolio. I also like how it explicitly excludes the top 10% of high-yield stocks, reducing the risk of investing in a yield trap. I'm less enthusiastic about VIG, though, since its yield and dividend growth rates are too low to differentiate it from the S&P 500. You can read my neutral review on VIG here.
Source: Created By Author Using Data From Seeking Alpha And Portfolio Visualizer
To conclude the large-cap dividend section, there looks to be a clear link between the following funds' poor performances and their high allocations to Technology stocks. The First Trust Rising Dividend Achievers ETF (RDVY), which I do like, has 30% Financials and 26% Technology. These two sectors underperformed last month, but the holdings tend to be highly profitable, so I'm still optimistic about it.
Source: Created By Author Using Data From Seeking Alpha And Portfolio Visualizer
Mid-Cap Dividend ETFs
There are very few mid-cap dividend ETFs available, and I generally try to avoid this category. One reason is that any momentum its holdings generate is thwarted once their market capitalizations reach the large-cap threshold. Also, large-cap companies that are demoted end up here, and since they are usually market-cap-weighted, these underperformers tend to have a relatively high weighting. It doesn't help that fees are higher, too.
The WisdomTree MidCap Dividend ETF (DON) is the largest by assets under management, but it looks to have few redeeming qualities. Its yield of 2.12% isn't spectacular, nor is its 3.79% five-year dividend growth rate. It also doesn't offer any reduced volatility, and I maintain my thesis that DON is a bloated fund that fails to eliminate poor-quality stocks.
Source: Created By Author Using Data From Seeking Alpha And Portfolio Visualizer
Small-Cap Dividend ETFs
The small-cap segment is generally more volatile, so I usually suggest dividend investors, who tend to have more conservative strategies, use these ETFs sparingly. Last month, however, proved that there may be some room for them after all. The Invesco S&P SmallCap High Dividend Low Volatility ETF (XSHD) performed the best, gaining 7.61%. XSHD could be a good choice in preparation for a correction. I do caution, however, about holding onto these types of funds after markets bottom out. As we learned in April 2020, reversals can be swift, and those not paying attention run the risk of missing out on significant returns found in market funds.
Source: Created By Author Using Data From Seeking Alpha And Portfolio Visualizer
High Dividend Yield ETFs
High dividend yield ETFs performed great last month, averaging a 7.44% gain. The best ETF for all categories was the First Trust Morningstar Dividend Leaders Index ETF (FDL), which gained 9.89%, followed by the popular Invesco S&P 500 High Dividend Low Volatility Portfolio ETF (SPHD). One ETF, in particular, that I feel looks strong right now is the iShares Core High Dividend ETF (HDV), which gained 7.81% last month and looks well set up for Q1 2022. I'm estimating HDV will yield an annualized 3.50% this quarter, and it's still priced attractively at just 17x forward earnings on a weighted-average basis.
Source: Created By Author Using Data From Seeking Alpha and Portfolio Visualizer
Also performing well were low-cost ETFs like the Schwab U.S. Dividend Equity ETF (SCHD) and the Vanguard High Dividend Yield ETF (VYM), which is also another attractively-priced choice. I think if you're going to go the high-yield route, it's best to choose a fund with some good quality screens. Some ETFs rotate into the highest yielding stocks on a fixed schedule. This approach can negatively affect total returns, given that dividend and value strategies overlap. Value investing requires patience, and these passively managed funds can end up dropping high-potential stocks too early.
Income Generation ETFs
ETFs focused on generating a high income, usually through some version of a covered call strategy, are becoming more popular, and I have identified 14 different ETFs for consideration. In December, the top performer was the CBOE Vest S&P 500 Dividend Aristocrats Target Income ETF (KNG), which returned 6.24%. It participated in most equity upside because it only writes options on a limited number of stocks. It trailed the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) by 0.30%, but I still think it's a solid choice for those looking to dip their toes into options-based ETFs. Those looking to be more aggressive could turn to ETFs like the Amplify CWP Enhanced Dividend Income ETF (DIVO), which has exceeded my expectations since I reviewed it in October. Or, you could take a unique route with the JPMorgan Equity Premium Income ETF (JEPI), which writes covered calls using complex equity-linked notes (analysis here).
Source: Created By Author Using Data From Seeking Alpha and Portfolio Visualizer
Generally speaking, these ETFs will be relatively expensive and will limit upside potential to varying degrees in exchange for a high income and possible downside protection. I suggest avoiding buying them simply for the high yield, though, and instead use them tactically during periods of high uncertainty.
Risk Management
If income isn't your focus, perhaps you'll be interested in these 13 funds designed to manage risk. Most use options, while others like the Pacer Trendpilot US Large Cap ETF (PTLC) use a combination of equities and short-term treasuries. I haven't looked at many of these in detail, so I can't offer any suggestions now, but it's a category I plan on looking more into this year.
Source: Created By Author Using Data From Seeking Alpha and Portfolio Visualizer
Risk, Concentration, and Turnover
The following tables highlight three metrics I believe are worth some attention when deciding which ETF to purchase:
1. Risk, as measured by beta (volatility to the overall market) and standard deviation (amount of variation for a set of returns). More specifically, I want to know which funds offer the best risk-adjusted returns, so I have also calculated two- and five-year return-to-risk ratios for every ETF listed in this article.
2. Concentration, as measured by the number of holdings and the percentage of assets in the top ten. Highly concentrated funds (i.e., low number of holdings, a high portion of assets in the top ten) can earn returns significantly different from the market.
3. Turnover, which is a measure of how quickly holdings are bought and sold for the most recent fiscal year. High turnover funds have their benefits because it resembles a more actively-traded approach. However, we all know active fund managers tend to underperform their passive benchmarks. My advice is to monitor these funds more closely, as frequent reconstitutions may result in a fund that no longer meets your objectives.
Source: Created By Author Using Data From Seeking Alpha and Portfolio Visualizer
As a starting point, I think the five-year return-to-risk ratio is a decent metric if you're new to dividend ETFs. In terms of the most established ones, VIG, DGRW, DGRO, and SCHD all have combinations of good risk-adjusted returns and low turnover, making them suitable core holdings. They're all concentrated to about the same degree, but SCHD, in particular, uses some pretty logical screens that have worked out in its ten-year history.
It's also a good idea to know the weighting scheme each ETF uses. Market-cap-weighted ETFs will probably include several mega-caps like Apple and Microsoft, and if your objective is to diversify from these types of stocks, look for a fund with a different method. Equal-weight ETFs are popular choices, but they may be problematic because they give just as much weight to poor-quality stocks as they do high-quality ones.
Final Takeaways
To conclude, I want readers to remember four things:
1. Have a bias toward large-cap dividend ETFs. They are generally cheaper, and you can always supplement them with modest allocations to small- or mid-cap funds. Fees also directly impact distributions, so you're much better off with low-cost, established funds.
2. ETFs that focus on income generation and risk management tend to trade away a lot of upside for what ends up being marginal downside protection. Yield is important, but so are total returns.
3. Passive investors may favor low-turnover ETFs since they are more predictable. There's a good chance the fund will look similar next year, and thus, it should require less attention. In contrast, high-turnover funds can have significantly different sector exposures as they reconstitute. These changes may be beneficial, but since the fund is operating on a rules-based Index and has no human intervention, some of the changes end up being ill-advised.
4. It was essential to display all ETFs side by side to help combat endowment bias. This bias, which most of us struggle with, occurs when you feel something is worth more than it is simply because you own it. We all look for evidence that we've made the right decision, which sometimes involves ignoring better-performing ETFs. Try to find out some more information on your alternatives rather than just reviewing the results of the ETFs you own.
I hope you found this article helpful and, as always, I welcome any suggestions. Just leave a comment down below, and I'll be happy to respond. Happy New Year!
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