January Dividend And Income ETF Report: The Ultimate Investors Guide

Summary

• Each month, I give a broad overview of 90 dividend, income, and risk-management-focused ETFs, selecting them from my database of about 750 funds.
• January was tough for equities as the S&P 500 lost 5.27% and the Nasdaq-100 dropped 8.75%. High-yield dividend ETFs showed their defensive powers, though, as the category gained 1.09%.
• Energy, Financials, and Consumer Staples were top-performing sectors, suggesting investors fled to both defensive stocks and those that should protect them from rising inflation and interest rates.
• We saw how important it was for investors in options-based ETFs to consider the quality of the underlying holdings first. Nasdaq-100 Options ETFs beat QQQ, but still produced steep losses.
• Use this article as a quick summary on periodic performances, risk-adjusted returns, yield, growth, turnover, and concentration, as well as links to more detailed analysis on selected ETFs.
• Looking for a helping hand in the market? Members of Hoya Capital Income Builder get exclusive ideas and guidance to navigate any climate. Learn More »

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Article Purpose

Welcome to the fifth edition of my monthly dividend and income ETF series, where I summarize key metrics for 90 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.

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I like to begin these articles by giving a complete picture of the U.S. equity ETF market. The table below provides median performance metrics for the 38 categories in my database of almost 750 ETFs, and I have sorted the categories in descending order by their January 2022 returns.

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For the second month in a row, dividend ETFs were among the top performers as the U.S. market flirted with a correction ahead of earnings season. In particular, the high-dividend-yield category had a median gain of 1.09%, while growth and thematic ETFs fell sharply. I see this normalization as inevitable since growth stocks had their turn immediately following the pandemic. Fundamentals eventually matter, and with slowing earnings surprises and falling expectations, investors are starting to pile into lower P/E stocks held in dividend and value ETFs.

Notice how Energy and Financials ETFs were among the best-performing in January, which I see is the result of inflation fears. I don't mind overweighting these sectors at the moment as a hedge because even if fears are overblown, it likely means the rest of your portfolio will pick up the slack. Risk management has to be the focus right now; chasing returns by trying to time the bottom is challenging and probably inappropriate for most dividend and income-focused investors.

Finally, I want to re-emphasize comments from last month about investing based on profitability. I find categorizing stocks based on profitability status beneficial because historical data shows how much the risk-reward proposition changes once speculation begins. You can indeed score big if you can forecast when the market will care little about fundamentals. However, take a lesson from the history books and don't be too greedy. As shown in the graph below, declines are swift and painful, and the turmoil that thematic ETFs like the ARK Innovation ETF (ARKK) are experiencing right now was entirely predictable.

Created By Author From The Kenneth French Data Library: Portfolios Formed On Earnings/Price

While 2020 saw unprofitable stocks gain 79.31%, that figure fell to 2.85% in 2021 and has continued to fall in January. In contrast, the line for profitable stocks is much more smooth. Now, I want to point out how only 15 large-cap S&P 500 stocks, or 0.59% of the Index, have forecasted negative earnings this year. Compare that figure with 889 small-cap Russell 2000 stocks, or 25.44% of the Index, and the choice is clear. If you think the bottom for unprofitable stocks is in, lean more into small caps. Otherwise, stick with the large caps.

Now that we understand what drove markets in January, let's look closer at the performance of the dividend, income, and risk management ETFs that are the subjects of this monthly series.

Total Market Dividend ETFs

There are very few ETFs that I consider to truly represent the total U.S. equity dividend market. The primary reason is that most are market-cap-weighted or dividend-dollar-weighted, and therefore, the most prominent companies still dominate. Small- and mid-cap exposure is almost an afterthought, and I view it as just a marketing strategy trying to justify higher fees. The truth is that it's better and cheaper to buy ETFs in each category in the exact proportions you want.

I could only find four with less than 80% allocated to large-cap stocks. The JPMorgan U.S. Dividend ETF (JDIV) was the top performer for the second consecutive month, and admittedly, its fees are low. However, it has minimal assets under management, especially compared with the First Trust Value Line Dividend ETF (FVD). Generally, these all probably aren't sufficient in the long run, but like any rules-based fund, opportunities can present themselves with each Index reconstitution.

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Large-Cap Dividend ETFs

Large-cap dividend ETFs had a median loss of 3.19%, but this was good news compared to the 5.27% loss for the SPDR S&P 500 Index ETF (SPY). Topping the list was the Global X S&P 500 Quality Dividend ETF (QDIV), followed by the Sound Equity Income ETF (SDEI) and the Invesco Dow Jones Industrial Average Dividend ETF (DJD). I had been meaning to write about DJD given how it's near the top of my Dividend ETF Rankings System I'm currently developing, so its strong January performance gives me a good excuse. As for SDEI, I contacted the fund provider twice, looking for more information on their stock selection process, but I never heard back. It's a shame since it's been the fourth-best-performer in the last year out of the 90 ETFs discussed in this series. Its $12 million in assets under management sure could use a boost, but I can't write an objective article if I don't understand the strategy.

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The iShares Core Dividend Growth ETF (DGRO) is a popular choice for many, and it performed reasonably well relative to SPY last month, losing 3.24%. I recently gave it a neutral review as I don't think the outperformance will continue by much going forward. However, its consistent double-digit dividend growth rate and low 0.08% expense ratio are perfect for dividend growth investors who desire a yield later rather than need one today.

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Finally, the Vanguard Dividend Appreciation ETF (VIG), the largest by AUM, was one of the worst-performing, falling 5.30% in January. It's what I cautioned about in my November article, as VIG didn't seem like it would offer the same downside protection as it had previously. Its 1.65% dividend yield and 7.82% five-year dividend growth rate wasn't much of a selling point either, especially given the alternatives.

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Mid-Cap Dividend ETFs

Like total market dividend ETFs, very few mid-cap dividend ETFs are available, and they all have high fees. Also, the mid-cap space requires a contrarian mindset, which doesn't match my philosophy for how markets work. It's contrarian because large-cap stocks that get demoted end up in the Index with a high weight and negative price momentum. On the other hand, the promoted small-cap stocks have positive price momentum but negligible influence. In my view, you're better off oscillating between small- and large-cap stocks depending on your outlook for how unprofitable stocks will perform, as described earlier.

With that said, I've listed the four options available. The ProShares S&P Midcap 400 Dividend Aristocrats ETF (REGL) is a popular choice, but the First Trust SMID Cap Rising Dividend Achievers ETF (SDVY) has been the best performer over the last three years. Like the First Trust Rising Dividend Achievers ETF (RDVY), SDVY incorporates cash flow to total debt into its screening process. I like this screen because it combines profitability and debt management, which could come in handy once rates rise.

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Small-Cap Dividend ETFs

As mentioned, investors should expect more volatility in small-cap stocks given their high growth prospects but sometimes unprofitable operations. Small-cap dividend ETFs are usually value-oriented, though, so they should be safer. For the second consecutive month, the Invesco S&P SmallCap High Dividend Low Volatility ETF (XSHD) performed the best, falling 2.87%, or 1.54% better than the Vanguard Small-Cap Value ETF (VBR), which I reviewed here. XSHD's long-term performance has been terrible, though, as it's yet to recover to 2019 levels.

The VictoryShares U.S. Small Cap High Dividend Volatility Weighted ETF (CSB) also performed relatively well in January and has beaten VBR by 18.44% in the last five years. It's promising, but I did recently have some words of caution for interested readers.

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High Dividend Yield ETFs

As the fourth-best-performing category in January with a median gain of 1.09%, high-dividend-yield ETFs primarily benefit from their low price-earnings ratios and better-than-average analyst earnings revisions. Note how even the worst-performing ETF in the category last month, the Schwab U.S. Dividend Equity ETF (SCHD), outpaced the S&P 500 by 2.54%. It's an excellent category to consider right now.

Since November, I have been bullish on the iShares Core High Dividend ETF (HDV), and at the end of the year, I reaffirmed my position. The WisdomTree U.S. High Dividend Fund (DHS) is another fund with some solid inflation protection through its Energy holdings, as explained here. I continue to believe these offer the best of both worlds: cheap valuations with enough inflation protection. It's where SCHD falls a bit flat, in my view, though it remains one of the best choices over the long run.

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Income Generation ETFs

Income Generation ETFs often involve some form of option writing, and I have listed 11 of them below. The First Trust BuyWrite Income ETF (FTHI) and the First Trust Hedged BuyWrite Income ETF (FTLB) were the two standouts, but six others were able to outperform the S&P 500 this month. However, the ones that didn't highlight an important point: investors should not overlook the quality of the underlying holdings.

To illustrate, QYLD, NUSI, and QYLG write options on the Nasdaq-100 Index, which fell 8.75% in January. They outperformed as one would expect, but the returns were still dismal. The same is true for the Global X Russell 2000 Covered Call ETF (RYLD), whose underlying Index fell 9.53% last month. Remember that volatility drives yield for options-based ETFs, and you should be satisfied with the underlying Index first rather than buying just for the high yield. Before the January correction, I recommended investors wait until earnings season was over before taking a position in QQQ. The double-digit yield is nice, but it's an awful lot of capital you may sacrifice if the Index is vulnerable.

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Risk Management

Risk Management ETFs are similar to those above, but yield is not the objective. Instead, it's the protection of capital, and most use either option writing or investing in short-term treasuries to do so. One of the more established ones is the WisdomTree Cboe S&P 500 PutWrite Strategy Fund (PUTW), which sells at-the-money puts on the S&P 500. Others, like the Pacer Trendpilot U.S. Large Cap ETF (PTLC), have the flexibility to adjust market exposure and even invest in T-Bills depending on market conditions. These strategies can get complicated, so it's essential you fully understand them before investing.

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Risk, Concentration, and Turnover

Readers of my ETF articles will know that I place a lot of importance on a fund's risk, concentration, and turnover rates. It's not always about returns, and since most ETFs launched in a decade where growth dominated value, past performance isn't always helpful. The tables below cover the following three areas:

1. Risk, as measured by beta (volatility to the overall market) and standard deviation (amount of variation for a set of returns). Two- and five-year return-to-risk ratios are provided, with higher numbers indicating better performance for the volatility taken.

2. Concentration, as measured by the number of holdings and the percentage of assets in the top ten. Highly concentrated ETFs may differ substantially from market funds, so these may be more appropriate for active investors.

3. Turnover, which is a measure of how quickly holdings are bought and sold for the most recent fiscal year. Most dividend ETFs follow a rules-based Index, and depending on the sensitivity of the fundamental metrics used and the frequency of reconstitutions, investors may end up with entirely different-looking portfolios each year. It's almost like they're actively managed, so I suggest keeping a close eye on high-turnover ETFs.

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The five-year return-to-risk ratio is a good starting point for new investors, and selecting established, diversified funds with low expense ratios should be the default position. SCHD, DGRO, and VIG are examples of such funds, and they are solid S&P 500 alternatives. Once you have your core positions selected, you can customize your dividend portfolio based on yield, growth, volatility, and other investment objectives.

Many of these ETFs are also great for diversification, but remember that most follow some variation of a market-cap-weighted method. For example, if you already own the S&P 500, you may be better off with an ETF that weights based on fundamentals. This way, it's less likely you'll have much overlap in your portfolio, and you can efficiently corner the U.S. equity market and tailor it to your specific objectives.

Final Takeaways

I have five takeaways for readers today:

1. Most unprofitable stocks are found in small-cap indices, and they inherently have more risk. Understanding how unprofitable stocks are trending can help guide your selections. At the end of years like 1999, 2003, 2009, and 2020, investors should have counted their lucky stars and cashed in on their incredible gains since history shows they're very likely to underperform the following year. Returns dipped to 2.85% in 2021, and already this year, thematic-themed ETFs are down an average of 12.29%. I think there's more room to fall, so I will be making it my practice to evaluate the profitability levels for every ETF I analyze going forward.

2. Avoid total market dividend ETFs primarily because they are unnecessarily expensive. You don't need these all-in-one funds since you can build your own for less cost and in the exact proportions you want. Instead, make a low-cost large-cap dividend ETF one of your core holdings and then add targeted ETFs from other categories that satisfy your investment objectives.

3. Treat highly concentrated, high turnover ETFs as if they were actively managed. In such funds, past performance metrics have limited usefulness at best and are misleading at worst since the fund's holdings change so much over time. Be prepared to monitor these funds closely to ensure your objectives aren't compromised with each reconstitution. A simple solution is to mark a calendar with each ETF's reconstitution date. It won't take long and can motivate you to review your portfolio regularly.

4. Option-based ETFs often require their underlying holdings to be quite volatile to deliver a high yield. This feature calls into question their appropriateness for risk-averse investors, so I strongly recommend making downside protection your key priority rather than yield. Also, if you select an ETF that writes options on a vulnerable Index, it will still be subject to most of that Index's downside. In short, first, ask yourself if you would take a position in the ETF's underlying Index. If you wouldn't, then no amount of yield is worth it.

5. By displaying all ETFs side by side, I hope you'll take this as an opportunity to evaluate any emotional and cognitive biases you may have. Last month, I reminded readers about endowment bias, which is when you feel something is worth more than it is simply because you own it. Another is conservatism bias, which is when we refuse to acknowledge new information and choose to cling to previously held favorable views about something. I attempted to combat this bias recently with my changed opinion of VIG. I encourage you all to take a second look at your alternatives to see if you're still satisfied with your holdings.

Thank you all for continuing to support this monthly series. It takes some time to put together, but I think it's important to step back and look at how the entire U.S. market is performing and not just follow the ETFs you currently own. I plan on writing articles for about ten of these ETFs throughout February, so I hope you'll find time to read them and as always, feel free to keep the conversation going in the comments section below.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SPY, DGRO, SCHD 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.