I want to highlight three funds, all from VictoryShares, that target high yielders but also layer on a degree of volatility protection in case things really go south, explains David Dierking, exchange-traded fund expert and editor of TheStreet's ETF Focus.
These ETFs won’t eliminate the possibility of losses altogether, but they can minimize downside risk. All have a yield of at least 3%, so they could be worth some consideration in today’s market. Let’s run them down.
Victory Shares U.S. Large Cap High Dividend Volatility Weighted ETF (CDL)
This fund tracks the Nasdaq Victory US Large Cap High Dividend 100 Volatility Weighted Index. The targeting method of the fund is fairly straightforward. It starts with a universe of up to the 500 largest publicly traded U.S. stocks (with a few additional filters, most notably that they must have positive net earnings over the trailing 12 months).
From there, it selects the top 100 highest yielding securities from that group of 500. The component weights within the index are determined by the inverse of the daily standard deviation of returns (volatility) over the last 180 trading days. Stocks with a lower demonstrated level of volatility get higher weights within the index and vice versa. Real estate is excluded.
The portfolio looks like you might expect. Utilities and consumer staples comprise a combined 40% of the fund. Financials are #2 at 18% as the only other sector with a double digit allocation. Healthcare is next at 9%. This is clearly a very defensive-tilted portfolio.
During typical times, CDL has been about 10-20% less volatile than the S&P 500, but actually become slightly more volatile during the COVID bear market. It experienced a deeper drawdown than the S&P 500 (41% vs. 33%) due to its overweights in financials and energy. It has since resumed its spot as the lower volatility option.
Since its 2015 inception, CDL has outperformed its benchmark, the Russell 1000 Value index, by a 126% to 88% margin, but trailed the S&P 500’s return of 140%.
VictoryShares U.S. Equity Income Enhanced Volatility Weighted ETF (CDC)
CDC is effectively the same fund as CDL with one big exception. It adjusts its allocation to stocks based on market returns. It can remain 100% invested in the index when stocks are not in the midst of a “significant market decline”, which VictoryShares defines as a pullback of at least 8%. If it breaks through that level, the fund can reduce its equity exposure to as little as 25%.
Here are the guidelines for determining exposure:
• Index decline of 0-8% — 100% index exposure & 0% cash
• Index decline of 8-16% — 25% index exposure & 75% cash
• Index decline of 16-24% — 50% index exposure & 50% cash
• Index decline of 24%-32% — 75% index exposure & 25% cash
• Index decline of 32%+ — 100% index exposure & 0% cash
The idea is fairly simple. It’s essentially a “buy the dip” strategy built on top of an already volatility-weighted portfolio. It makes an immediate 100% to 25% equity exposure pivot at the 8% level because corrections of that magnitude tend to get deeper over time.
Therefore, it reduces most exposure immediately. It then begins adding equities back as losses deepen. Essentially, CDC is buying as volatility is high and losses more extreme. The research paper I co-authored confirmed this strategy finding that the best time to buy is when the VIX is high.
Over the past five years, CDC’s strategy has done a great job of producing superior risk-adjusted returns. It’s outperformed CDL by 2% annually and the Russell 1000 Value index by 4% annually during that time while doing so with about 17% less volatility. It carries the highest possible 5-star rating from Morningstar.
VictoryShares U.S. Small Cap High Dividend Volatility Weighted ETF (CSB)
CSB is essentially the small-cap version of CDL. Instead of targeting the 500 largest companies, it starts with a universe of stocks with a market cap of under $3 billion. The same weighting criteria applies.
CSB measures itself against the Russell 2000 Value index and has similarly been able to outperform with lower volatility. It’s beaten the index by 3% annually over the past five years with 10% less volatility.
High Yields
All three funds offer yields in the 3-4% range. That’s the area where a lot of the safe higher yielders reside, but don’t get into the area of speculative yield. Above 4% you start getting into the area where there’s the risk of yields looking artificially high due to share price declines.
The overweights to utilities, consumer staples, financials and energy support the notion that these are more cash-rich companies that are paying these dividends. CDC and CDL offer a current yield of 3.4%, while CSB is at 3.3%
If 2022 is going to be all about risk management, which I think it should be, all three of these funds offer good ways to moderate your equity exposure. CDC, in my opinion, is the best of the bunch due to the addition of the asset class rotation strategy. Backing off of equities during the early stages of a decline, but adding back exposure as declines deepen has been a strategy proven to work over the long-term.
