Dividend-focused smart-beta funds tend to pick a subset of the index with the most constant dividend record. Some of the funds are further screened for financial stability or a record of increases in dividends.
I need to mention that while high dividends have intuitive appeal, there are two caveats.
First, in theory, dividend-paying companies may simply be those without any better ideas to invest their money. Another way of looking at that is that you'd probably rather have a company you own invest in a project with 15 percent return than have it pay 3 percent back to you. On the other hand, some think that dividends force management to be more disciplined.
Second, because of tax law, companies also buy back stock instead of paying dividends. In fact, in 2013, the "buyback yield" exceeded the dividend yield. (See this paper by NYU's Aswath Damodaran for more information). It's not clear how this shift will affect returns of dividend-focused funds in the future.
Despite my comments above, I am going to use the fund's published indexes, minus the current ETF fees, instead of looking at the ETFs. That will give us a longer period to analyze. In general, the managers of these funds track their indexes as closely as possible. I'll look at two time periods: a longer one from 2001-2014; and a post-financial crisis from 2010-2014.
I'm looking at the bigger funds, roughly $300 million or more. The table below shows the compounded annualized growth rate and the annualized return, divided by the standard deviation to give a sense of the index's risk-adjusted returns. The worst drawdown—the maximum loss from peak—is also reported.
Dividend-focused ETFs, performance of index tracked by funds, adjusted for fees
2001-2014. Sources: Bloomberg, ETF.com, Astor calculations
So, how have these indexes done over time?
For the seven indexes that have been extended back to 2001, all outperformed the S&P 500. In addition, all seven outperformed the S&P 500 on a risk-adjusted basis. However, when we look at returns through the lens of the worst drawdown, another measure of risk, we see the results are more ambiguous.
While these results are good, for a more cautious interpretation of dividend focused funds with different data, see Larry Swedroe's article on ETF.com from last summer, distinguishing between high dividend and value strategies.
Also note that the funds that simulate the best have been calculated in real time for the shortest amount of time. Even in the more recent period, when the S&P 500 has done quite well, the high-dividend funds have outperformed on both an absolute and risk-adjusted basis.
Note that the average correlation of the indexes to each other is about 0.92, and the average correlation to the S&P 500 is 0.91. In other words, not much diversification benefit to your core equity portfolio here. To earn a place in your portfolio, you have to believe these indexes will continue to produce superior risk-adjusted returns.
Astor Investment Management is a money manager with an active and economically grounded approach to asset allocation. We believe that investment opportunities arise based on the ability to identify fundamental trends and changes in the economy. We build portfolios of ETFs appropriate for our analysis of the business and monetary policy cycles. For more information, see www.astorim.com; for our blog, see www.astorinsights.com.