3 Pointers On A New Dividend Growth ETF

A new fund from a new ETF issuer is offering something truly unique in the ETF marketplace: true dividend-growth exposure.

The allure of pure-play dividend growth is straightforward: stable growth from increasing cash flows of large dividend-paying firms without the noise and volatility from the underlying stock movements.

The fund is the Reality Shares DIVS ETF (DIVY), and here are three things you need to know about it:

• Seeks Pure-Play Dividend Growth

Unlike most dividend-growth funds, DIVY has no gain or loss from the underlying stock prices. For that matter, it doesn’t get any return from constant dividend amounts.

Instead, it aims to gain solely from any growth in the dividend stream. Put differently, the fund will only improve when the actual dividends paid out exceed the expected dividends, as expressed in options prices. The fund relies exclusively on somewhat-complex derivatives exposure—more on this below—but the key point here is that it’s a pure dividend-growth play, all by way of acknowledging that stable dividends get you nowhere in the long run.

• Not An Income Play

This just in: Many folks come to dividends for income. And if that income is growing, that’s even better.

DIVY is different. It seeks only the growth on the dividends, not the baseline dividends themselves. As an example, if DIVY has exposure to Acme BlueChip Inc., which pays $2 every quarter like clockwork, that’s a zilch for DIVY. DIVY only gains if Acme BlueChip raises its dividend.

Again, the goal for DIVY is steady growth that comes only from dividend growth.

• A Lot Going On Under The Hood

Here’s a summary of the machinations in one brief section: DIVY relies on put-call parity to back out exposure to dividends using options. That means the fund goes long the put and short the call for the same strike and expiry.

It takes a long position in this synthetic dividend (my words, not theirs) at about three years out, and a short position at about one year out. As time passes and the actual values converge on expected values, the net position captures actual growth that wasn’t originally priced into the options—the risk premium, in other words. The fund hedges out interest-rate risk that’s also a factor in options pricing.

While the fund’s prospectus does a great job laying this out, in my view, there are still enough moving parts to send me back to notes from my favorite derivatives professor.

I suspect most people don’t have a favorite derivatives professor, which helps to make my point: There’s sufficient complexity here in the inner workings to give pause to a prudent investor.

Still, I’m less worried about investors betting on something they don’t understand than on something they don’t want. Again, the thesis here is modest-but-steady price appreciation—not income.

One clarification: While the prospectus explicitly names markets in Europe and Japan as fair game, I understand (from marketing materials and conversations with the issuer) that the fund will focus on the U.S. markets; namely, the S&P 500 and the Nasdaq-100. I encourage the issuer to update its prospectus soon.

At the time this article was written, the author held no positions in the security mentioned. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.