Don’t Yield to Dividends
RJ Steinhoff, CFA Investment Process Dividend Investing
Many investors have looked to high dividend-paying stocks to replace lost income from plunging bond yields. With dividend strategies yielding over 5%, the after-tax spread over government and corporate bonds is tantalizing. While clearly more volatile than corporate or government bonds, high dividend-yielding stocks are often viewed as being less volatile and of higher quality than non-dividend-paying stocks; their dividend stream is seen as a proxy for robust and consistent cash flow generation.
The investment industry is more than happy to satisfy this demand. According to FactSet, Vanguard’s Dividend Appreciation ETF was the tenth most popular ETF in 2019 and FundLibrary.com lists 1,057 dividend and equity income mutual funds for Canadian investors to choose from.
We counsel clients that dividend-paying stocks do not necessarily deserve their reputation for safety and dependability. The poor performance of high-yielding stocks during the March correction serves as a reminder that these stocks are not insulated from market drawdowns. As we pointed out in The ‘High-Low’ Approach to Identify Outperformers, between the S&P 500’s peak on February 19 to its most recent bottom on March 23, the top 40 highest yielding stocks in the S&P 500 had an average decline of 46%, worse than the average S&P 500 constituent’s 39% decline.
Similarly, dividend-focused ETFs experienced large drawdowns during March. Table 1 lists the performance for the ten largest dividend-focused U.S. ETFs during the February-March correction. Eight of the top ten ETFs fared worse than the SPDR S&P 500 ETF. Over the last five years, the annualized standard deviation for the group was 17.9%, in-line with the SPDR S&P 500 ETF. Total return (i.e., inclusive of dividends) over the last five years for these funds was worse than the plain vanilla S&P 500 ETF. The bottom line: no real drawdown protection, volatility on par with the market, and inferior longer-term returns.
TABLE 1. PERFORMANCE OF THE TOP 10 DIVIDEND-FOCUSED ETFs FEB 19, 2020 – MAR 23, 2020
| Ticker | ETF Name | March Drawdown | 5 Year Annualized Standard Deviation | 5 Year Annualized Return |
|---|---|---|---|---|
| SPY | SPDR S&P 500 ETF Trust | -33.7% | 18.5% | 7.8% |
| VIG | Vanguard Dividend Appreciation ETF | -31.6% | 17.4% | 8.5% |
| VYM | Vanguard High Dividend Yield Index ETF | -34.6% | 17.8% | 4.8% |
| DVY | iShares Select Dividend ETF | -40.8% | 18.5% | 2.8% |
| DGRO | iShares Core Dividend Growth ETF | -34.8% | 18.4% | 8.0% |
| FVD | First Trust Value Line Dividend Index Fund | -35.1% | 16.9% | 5.6% |
| HDV | iShares Core High Dividend ETF | -35.3% | 17.4% | 3.7% |
| NOBL | ProShares S&P 500 Dividend Aristocrats ETF | -35.0% | 17.6% | 6.1% |
| DGRW | WisdomTree US Quality Dividend Growth Fund | -31.9% | 18.0% | 7.8% |
| SPHD | Invesco S&P 500 High Dividend Low Volatility ETF | -39.8% | 18.7% | 2.7% |
| DLN | WisdomTree U.S. LargeCap Dividend Fund | -35.5% | 18.3% | 5.8% |
SOURCE: FACTSET, GENERATION PMCA CORP.
Looking more broadly, we compared the performance of the MSCI World High Dividend Index to its MSCI World Index counterpart since its inception in 1995. Drawdowns through the four bear markets since 1995 have been similar for the two indexes. Interestingly, the MSCI World High Dividend Index experienced slightly larger drawdowns than the MSCI World Index through the Great Recession and March COVID-19 declines. Though, the seismic shift from technology stocks towards high yield and value during the dot-com bubble implosion benefited the MSCI World High Dividend Index.
TABLE 2. PERFORMANCE OF THE MSCI WORLD INDEX AND THE MSCI WORLD HIGH DIVIDEND INDEX DURING MAJOR BEAR MARKETS SINCE 1995
| Index | Annualized Standard Deviation (Jan 1 ’95 – Apr 30 ‘20) |
COVID-19 Correction (Jan ’20 – Mar ’20) | Great Recession (Jun ’07 – Mar ’09) | Dot-com Bubble (Jan ’00 – Mar ’03) | 1998 Bear Market (Jun ’97 – Oct ’98) |
|---|---|---|---|---|---|
| MSCI World Index (USD) | 15.7% | -33.4% | -57.7% | -45.6% | -23.8% |
| MSCI World High Dividend Index (USD) | 15.2% | -33.3% | -61.6% | -25.9% | -18.6% |
SOURCE: FACTSET, GENERATION PMCA CORP.
At the portfolio level, asset allocation is critical; the weighting of income and equities is the driving factor for portfolio volatility and income generation. Rather than emphasizing dividend yield in an attempt to achieve less volatile returns, clients should focus on their mix of equities, fixed income, and alternative strategies that utilize hedging strategies. Within the equity allocation, less volatile stocks can be selected by emphasizing metrics such as return on invested capital (ROIC), leverage and liquidity ratios, valuation, and historical volatility. Once these companies have been identified, higher-yielding stocks can be selected if an income stream is specifically desired.
RJ Steinhoff, CFA
Director of Research
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation PMCA Corp. may or may not continue to hold any of the securities mentioned. Generation PMCA Corp., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation PMCA Corp. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation PMCA Corp. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.
Many investors have looked to high dividend-paying stocks to replace lost income from plunging bond yields. With dividend strategies yielding over 5%, the after-tax spread over government and corporate bonds is tantalizing. While clearly more volatile than corporate or government bonds, high dividend-yielding stocks are often viewed as being less volatile and of higher quality than non-dividend-paying stocks; their dividend stream is seen as a proxy for robust and consistent cash flow generation.
The investment industry is more than happy to satisfy this demand. According to FactSet, Vanguard’s Dividend Appreciation ETF was the tenth most popular ETF in 2019 and FundLibrary.com lists 1,057 dividend and equity income mutual funds for Canadian investors to choose from.
We counsel clients that dividend-paying stocks do not necessarily deserve their reputation for safety and dependability. The poor performance of high-yielding stocks during the March correction serves as a reminder that these stocks are not insulated from market drawdowns. As we pointed out in The ‘High-Low’ Approach to Identify Outperformers, between the S&P 500’s peak on February 19 to its most recent bottom on March 23, the top 40 highest yielding stocks in the S&P 500 had an average decline of 46%, worse than the average S&P 500 constituent’s 39% decline.
Similarly, dividend-focused ETFs experienced large drawdowns during March. Table 1 lists the performance for the ten largest dividend-focused U.S. ETFs during the February-March correction. Eight of the top ten ETFs fared worse than the SPDR S&P 500 ETF. Over the last five years, the annualized standard deviation for the group was 17.9%, in-line with the SPDR S&P 500 ETF. Total return (i.e., inclusive of dividends) over the last five years for these funds was worse than the plain vanilla S&P 500 ETF. The bottom line: no real drawdown protection, volatility on par with the market, and inferior longer-term returns.
TABLE 1. PERFORMANCE OF THE TOP 10 DIVIDEND-FOCUSED ETFs FEB 19, 2020 – MAR 23, 2020
| Ticker | ETF Name | March Drawdown | 5 Year Annualized Standard Deviation | 5 Year Annualized Return |
|---|---|---|---|---|
| SPY | SPDR S&P 500 ETF Trust | -33.7% | 18.5% | 7.8% |
| VIG | Vanguard Dividend Appreciation ETF | -31.6% | 17.4% | 8.5% |
| VYM | Vanguard High Dividend Yield Index ETF | -34.6% | 17.8% | 4.8% |
| DVY | iShares Select Dividend ETF | -40.8% | 18.5% | 2.8% |
| DGRO | iShares Core Dividend Growth ETF | -34.8% | 18.4% | 8.0% |
| FVD | First Trust Value Line Dividend Index Fund | -35.1% | 16.9% | 5.6% |
| HDV | iShares Core High Dividend ETF | -35.3% | 17.4% | 3.7% |
| NOBL | ProShares S&P 500 Dividend Aristocrats ETF | -35.0% | 17.6% | 6.1% |
| DGRW | WisdomTree US Quality Dividend Growth Fund | -31.9% | 18.0% | 7.8% |
| SPHD | Invesco S&P 500 High Dividend Low Volatility ETF | -39.8% | 18.7% | 2.7% |
| DLN | WisdomTree U.S. LargeCap Dividend Fund | -35.5% | 18.3% | 5.8% |
SOURCE: FACTSET, GENERATION PMCA CORP.
Looking more broadly, we compared the performance of the MSCI World High Dividend Index to its MSCI World Index counterpart since its inception in 1995. Drawdowns through the four bear markets since 1995 have been similar for the two indexes. Interestingly, the MSCI World High Dividend Index experienced slightly larger drawdowns than the MSCI World Index through the Great Recession and March COVID-19 declines. Though, the seismic shift from technology stocks towards high yield and value during the dot-com bubble implosion benefited the MSCI World High Dividend Index.
TABLE 2. PERFORMANCE OF THE MSCI WORLD INDEX AND THE MSCI WORLD HIGH DIVIDEND INDEX DURING MAJOR BEAR MARKETS SINCE 1995
| Index | Annualized Standard Deviation (Jan 1 ’95 – Apr 30 ‘20) |
COVID-19 Correction (Jan ’20 – Mar ’20) | Great Recession (Jun ’07 – Mar ’09) | Dot-com Bubble (Jan ’00 – Mar ’03) | 1998 Bear Market (Jun ’97 – Oct ’98) |
|---|---|---|---|---|---|
| MSCI World Index (USD) | 15.7% | -33.4% | -57.7% | -45.6% | -23.8% |
| MSCI World High Dividend Index (USD) | 15.2% | -33.3% | -61.6% | -25.9% | -18.6% |
SOURCE: FACTSET, GENERATION PMCA CORP.
At the portfolio level, asset allocation is critical; the weighting of income and equities is the driving factor for portfolio volatility and income generation. Rather than emphasizing dividend yield in an attempt to achieve less volatile returns, clients should focus on their mix of equities, fixed income, and alternative strategies that utilize hedging strategies. Within the equity allocation, less volatile stocks can be selected by emphasizing metrics such as return on invested capital (ROIC), leverage and liquidity ratios, valuation, and historical volatility. Once these companies have been identified, higher-yielding stocks can be selected if an income stream is specifically desired.
DISCLAIMER
The information contained herein is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Nothing contained herein shall constitute an offer, solicitation, recommendation or endorsement to buy or sell any security or other financial instrument. Investment accounts and funds managed by Generation PMCA Corp. may or may not continue to hold any of the securities mentioned. Generation PMCA Corp., its affiliates and/or their respective officers, directors, employees or shareholders may from time to time acquire, hold or sell securities mentioned.
The information contained herein may change at any time and we have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. It should not be assumed that any of the securities transactions or holdings mentioned were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities mentioned. Past performance is no guarantee of future results and future returns are not guaranteed.
The information contained herein does not take into consideration the investment objectives, financial situation or specific needs of any particular person. Generation PMCA Corp. has not taken any steps to ensure that any securities or investment strategies mentioned are suitable for any particular investor. The information contained herein must not be used, or relied upon, for the purposes of any investment decisions, in substitution for the exercise of independent judgment. The information contained herein has been drawn from sources which we believe to be reliable; however, its accuracy or completeness is not guaranteed. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained herein. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained herein.
All products and services provided by Generation PMCA Corp. are subject to the respective agreements and applicable terms governing their use. The investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation.