A High-Payout ETF Checkup

January 09, 2012

 

 

Sure, SDIV has over 15 percent of its holdings in financials and financial service firms, but that’s not enough to justify such a poor showing. After all, First Trust’s FGD has 19 percent of its assets in financials, and it was the best-performing fund of the group. What’s more, ABCS has less than a 5 percent weighting to the sector, and it was the worst of the lot.

It would also be easy to say the better-performing funds were probably more defensive, owning to consumer staples, one of the most defensive pockets of the equities universe. But if that were the only reason for the fund’s better performance, you wouldn’t expect to see 12 percent of ABCS’ portfolio in that sector compared with just 4 percent for FGD.

It seems something else is at play here. The quickest way to get to the bottom of this is probably to look at the methodology of the underlying indexes. Even a quick glance likely tells us all we need to know. The best-performing funds both had different iterations of the same screening criteria:

  • History of paying dividends
  • Historical dividend growth rate
  • Maximum dividend payout ratios

 

These qualifiers help to eliminate companies with temporarily high dividend yields that the market expects are about to come down. In fact, dividend cuts are likely a big driving force behind the declines of both of the newer funds. For instance, take a look at the only dividend “stability check” in the Solactive Global SuperDividend Index:

“Dividend Forecast is at least stable, i.e. there is no official announcement as of the selection day that dividend payments will be cancelled or significantly reduced in the future.”

What that means in practice is that unless a company has made an official announcement of a dividend cut, the payout is considered stable.

Any investor in dividend-paying companies knows all too well that companies trading with extremely high yields are often being priced that way by the market because the market doesn’t believe the dividend is sustainable.

That doesn’t mean the market is right, and people have made a ton of money buying high-yielding stocks with the belief the dividend is sustainable and the share price will recover to more accurately reflect that reality.

In fact, ABCS has no such stability screen—a possible explanation for the fund’s worst-in-class performance since June.

The bottom line for investors is, unlike a bond, a dividend payment is not an obligation.

A company that doesn’t have a long history of paying a dividend, let alone raising its payout, is in some ways, barely more likely to pay a future dividend than a company that doesn’t even pay a dividend.

In other words, owning a high-dividend ETF that holds companies that lack such a history is a bit risky.

Your best bet is to choose a fund that attempts to quantify the sustainability of a company’s dividend, focusing not just on recent history. Sure, none of these portfolios did very well in the past year, but those that used these sustainability screens performed much better.

In short, if you’re looking for steady dividend yields to augment a sideways or even down-trending market, there is no shortcut.

 

Find your next ETF

Reset All