Dividend stocks have been one of the biggest winners of 2022 and I think that outperformance trend is likely to continue throughout the remainder of the year, suggests David Dierking, editor of The Street's ETF Focus.
The real catalyst for equities putting in a bottom is a dovish pivot from the Fed. Part of the reason risk assets rallied in July was because of the perception that the Fed may be getting close to the point of backing off on tightening conditions. As long as the Fed’s #1 goal is inflation control, however, I don’t see a reason to expect a longer-term move higher just yet.
There are all flavors and strategies within the dividend ETF universe, but I think those that take more of a defensive approach will play better in this market. I’m going to offer up three dividend ETFs that meet that criteria, but layer a second strategy on top of that - low volatility, high yield and sector allocation.
VictoryShares U.S. Equity Income Enhanced Volatility Weighted ETF (CDC)
If you’ve followed my work in the past, you’ll know that I’m a big fan of this ETF. There are a lot of things going on within this fund’s strategy, but the overall high level view is that it aims to deliver equity market returns, an above average yield, managed risk levels and downside protection.
CDC starts by pulling the 100 highest yielding stocks out of a universe of the 500 largest U.S. stocks. The weightings in the ETF’s index are based on the inverse of the daily standard deviation of returns over the prior 180 days. Additionally, the fund will pare back equity exposure during market downturns.
For example, CDC has reallocation triggers at every 8% decline in the large-cap index. At an 8% correction, the fund goes from 100% equity exposure to 25%. At every additional 8% decline, it adds back 25% equity exposure to the point where it goes a full 100% back into equities with a 32% market drawdown. Think of it as getting mostly out during the initial decline, but attempting to buy the dips as stocks fall further.
Historically, this has been a top tier ETF among those using similar strategies. It has earned a 5-star rating from Morningstar and its returns land it in the top 3% of more than 1,000 funds in Morningstar’s Large Value category.
Invesco S&P 500 High Dividend Low Volatility ETF (SPHD)
SPHD’s strategy follows a similar path to that of CDC without the “enhanced” weighting strategy. As I’ve discussed with this fund in the past, it’s been either a feast or famine type of ETF. From 2017 through 2021, when growth, tech and high beta stocks were all the rage, SPHD had a really tough time.
In 2022, when defensive stocks, low volatility and dividend payers have been the leaders, SPHD has shined (relatively speaking, of course, but the fund is up 1% on the year)!
SPHD starts with the S&P 500 and pulls out the 75 highest yielders, REITs included. Within that sub-universe, it targets the 50 names with the lowest realized volatility over the past 12 months and weights all qualifying components by their dividend yield. What you end up with is a portfolio that has been about 25% less volatile than the S&P 500 over the past year and offers a current yield of almost 4%.
FlexShares Quality Dividend Defensive Index ETF (QDEF)
The FlexShares dividend ETFs (this one along with QDF, QDYN and the international counterparts to each) focus on stocks backed by healthy balance sheets, have above average yields and have the ability to continue growing their dividends over time. QDF is probably my favorite out of the bunch based on its broader approach, but QDEF is perhaps the better ETF for this moment.
It starts with a universe of 1,250 large- and mid-cap stocks and immediately eliminates non-dividend payers. Using quality and fundamental metrics, it assigns a dividend quality score to each remaining stock and avoids any one of them that lands in the bottom quintile.
From there, a portfolio optimization process is used that looks to accomplish three things — maximize overall quality score, pay an above average yield and maintain a portfolio beta between 0.5 and 1.0. The quality and low volatility aspects of this portfolio are probably the most beneficial today since the current 2.4% yield isn’t that much above average.
