KBWD: High-Risk, High-Return, High-Yield Financial ETF - 7.3% Dividend Yield

Summary

• KBWD is a high-yield financial index ETF.
• The fund offers investors a strong 7.3% dividend yield and potential capital gains.
• Risk, volatility, and losses during downturns are quite high too.
• This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »

cemagraphics/iStock via Getty Images

The Invesco KBW High Dividend Yield Financial ETF (NASDAQ:KBWD) is an index ETF investing in the highest yielding financials, including BDCs, mREITs, banks, and the like. KBWD's holdings have very strong yields, the fund itself has a 7.3% dividend yield, but are riskier than average too. KBWD is a classic high-risk high-return investment opportunity, but one that will, I believe, perform quite well in the future. It is a buy, but only appropriate for more aggressive income investors and retirees.

KBWD Basics

• Sponsor: Invesco
• Underlying Index: KBW Nasdaq Financial Sector Dividend Yield Index
• Dividend Yield: 7.30%
• Management Fee: 0.35%
• Total Returns CAGR (Inception): 7.65%

KBWD Overview

KBWD is an index ETF, tracking the KBW Nasdaq Financial Sector Dividend Yield Index, an index of high yield U.S. financials. It is a reasonably simple index, including the highest yielding U.S. financials, subject to a basic set of trading, liquidity, float, and dividend sustainability criteria. It is a dividend-weighted index: the higher the yield, the greater the weight. There are security and industry caps to ensure a modicum of diversification. Besides this, nothing much else stands out about the fund's index.

KBWD itself invests in 40 securities, a reasonable number for a niche industry equity fund. Concentration is a bit higher than average, with the fund's top ten holdings accounting for 36% of its value. These are as follows.

(Source: KBWD Corporate Website)

From what I've seen, KBWD's holdings are roughly evenly divided between:

• BDCs, which focus on loans to small and medium-sized private equity companies
• mREITs, which focus on leveraged mortgage investments
• Community banks and other small-cap financials, which focus on more traditional financial services

As the fund overweights securities with particularly strong dividend yields, its largest holdings are generally mREITs, which have the highest yields. mREITs are also riskier than average, as excessive use of leverage is common in the sector. In general terms, the fund's holdings are riskier and smaller than average, as a consequence of focusing so strongly on dividend yields.

KBWD's strategy and holdings provide investors with several strong benefits and drawbacks. Let's have a look at these, starting with the benefits.

KBWD - Benefits and Investment Thesis

Strong 7.3% Dividend Yield

KBWD focuses on the highest yielding financials in the market, which results in a comparatively high yield fund. KBWD sports a strong 7.3% trailing twelve months yield, and an even stronger 7.9% forward dividend yield. Forward dividends are higher, and more informative, as the fund has been hiking its dividend all year. The fund's 7.3% dividend yield is quite high on an absolute basis, and much higher than that of all relevant broad-based equity and financial industry indexes.

Data by YCharts

KBWD's dividends, as those of the vast majority of ETFs, are fully covered by underlying generation of income. There are no destructive return of capital distributions or similar, it is pure income.

(Source: KBWD Corporate Website)

KBWD's dividends have also seen consistent hikes throughout the year, growing 11.5% during 2021. Growth is due to underlying holding dividend growth which is, in turn, due to improved economic fundamentals and underlying holding financial performance. Future dividend growth is dependent on continued economic strength, both of which seem likelier than not.

(Source: Seeking Alpha)

KBWD's strong, fully-covered, growing 7.3% dividend yield is a significant benefit for the fund and its shareholders, and KBWD's core investment thesis. This is an income vehicle, and is meant for income investors.

Cheap Price and Valuation

KBWD's share price has come down by a bit these past six months, unlike that of most equity indexes, which presents something of a buying opportunity for investors.

Data by YCharts

As can be seen above, KBWD is down 2%, while the S&P 500 is up by 10%. Cheaper prices are almost wholly due to investor sentiment: fundamentals remain strong, as evidenced by the fund's growing dividend.

KBWD's valuation itself is also quite cheap. The fund sports a 13.0x PE ratio and a 1.7x PB ratio, both significantly lower than those of most broad-based equity indexes. For reference, the S&P 500 sports a PE ratio of 24.4x, PB ratio of 4.5x.

KBWD's valuation is also cheaper than that of most other equity sub-segments. As per the fund's management, KBWD focuses on small-cap value securities, which makes sense considering the fund's BDC and mREIT holdings.

(Source: KBWD Corporate Website)

As per J.P. Morgan, small-cap value stocks are the only equity sub-segment trading below their historical average valuations. Everything else is overvalued.

(Source: J.P. Morgan Guide to the Markets)

KBWD's cheap valuation benefits investors in two key ways.

First, lower share prices equal higher dividend yields, a strong, self-evident benefit for investors. KBWD is an income vehicle, so maximizing an investor's yield on cost is of utmost importance, and buying on moments of weakness is an easy way to accomplish this.

Second, lower share prices could lead to strong capital gains and market-beating returns, assuming valuations normalize. This is a big assumption, but a likely one, in my opinion at least. Large valuation gaps rarely persist long-term, and they were narrowing before November, for both KBWD specifically, and financials in general.

Data by YCharts

The trend reversed itself these past few months but, as mentioned previously, fundamentals remain strong. Market sentiment shifts all the time, and buying on moments generally leads to strong returns, as has been the case for most of the year.

KBWD's cheap valuation increases the fund's dividend yield, and could lead to strong capital gains in the coming months, a solid combination.

Economic Tailwinds

Finally, KBWD should benefit from two current economic trends: strong economic growth, and rising interest rates.

Improved economic fundamentals lead to lower default rates, ensuring strong earnings for financials focusing on risky debt.

Higher interest rates lead to higher revenues from most financials, for obvious reasons, although some of the impact is blunted by higher financing costs for these same companies. The net effect is generally positive, however.

Both economic trends should benefit KBWD, ultimately leading to growing dividends, strong capital gains, and market-beating returns.

Drawbacks and Risks

KBWD's dividend yield and potential returns are quite strong, but the fund is also a comparatively risky investment, with many drawbacks. Three stand out, the fund's: risky holdings, long-term dividend cuts, long-term underperformance. Let's have a look at these.

Risky Holdings

KBWD focuses on BDCs, mREITs, and smaller community banks. These are niche, comparatively risky securities, which make for an incredibly risky fund. Expect significant losses and underperformance during downturns and recessions, as was the case during 1Q2020, the onset of the coronavirus pandemic. KBWD significantly underperformed relative to the S&P 500, and financial equity indexes, during said time period.

Data by YCharts

KBWD's risky holdings make the fund a relatively risky investment. As such, the fund is only appropriate for more aggressive income investors and retirees.

Long-term Dividend Cuts

KBWD's long-term dividend growth track-record is quite negative, with the fund seeing declining dividends since inception. Dividends are generally cut during / in the aftermath of recessions, as was the case during the pandemic, and during the financial crisis. Dividends are down by about 30%-50% since inception, incredibly negative results.

(Source: Seeking Alpha)

Long-term Underperformance

KBWD's holdings are quite risky, with significant capital losses and dividend cuts during downturns and recessions. It is quite common for excessively risky holdings to underperform in the very long-term, as capital losses and dividend cuts are simply inconsistent with strong long-term performance. KBWD performs quite well during bull markets, but its long-term performance track-record is sub-par, with the fund significantly underperforming since inception.

Data by YCharts

In my opinion, and considering KBWD's long-term dividend cuts and underperformance, the fund is not an appropriate long-term, set it and forget it fund. It is appropriate to buy and hold KBWD when its price is low and the economy is strong, as is currently the case, less appropriate to just buy and hold at any price.

Looking Back

Around six months ago I wrote a bearish article on KBWD, centered on the fund's then weak yield and overvalued holdings. I thought a quick look at what made me change my mind might be of interest to readers.

In short, since I last covered KBWD, the fund's dividend has grown by about 11%, its price has gone down by about 3%, and its valuation has improved. The fund's fundamentals are much stronger today, and getting stronger every month of dividend growth. Besides, sustained dividend growth is evidence of underlying holding strength / performance, both of which seemed materially weaker in the past. Improved fund fundamentals and underlying holding performance made me change my mind about KBWD.

Conclusion

KBWD's strong 7.3% dividend yield and prospective returns make the fund a buy. As the fund focuses on very risky holdings, it is only appropriate for more aggressive income investors and retirees.

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.

Comments

[Sheryldell]

Trading volume is low, AUM is low. This could be difficult to get out of if market is volatile.