The explosive growth of ETFs over the past few years has been impressive
CHART: the chart above shows the growth in the number of ETFs since 2001. Note that ETFs doubled between 2001 and 2005. Here is the growth in the number of ETFs between the following years and the end of 2012: [1]
From 2006 233%
From 2007 90%
From 2010 27%
Even more impressive is the growth of total assets invested in ETFs over these years. [2]
CHART: The chart below shows the asset growth within the ETF space between 2001 and 2012. Note the meteoric rise in assets through these years. For example: Between 2001 and 2005, assets grew by 263%. In 2006, assets grew 41%. For 2007, asset growth was 44%. Between 2007 and 2010, assets grew 63%. Most recently, assets grew 35% between 2010 and December 2012.[3]
Most of these ETFs use an investment strategy/policy built upon some form of market “index”. Some of these indices are well known (S&P 500 Index; Russell 2000 Index; Dow Jones Industrial Index; etc.) while others are more obscure (NASDAQ US Dividend Achievers Select Index; Dow Jones U.S. Select Dividend Index; S&P High Yield Dividend Aristocrats Index). Needless to say, the “index creation” business has become much more than a “cottage industry”. In fact, Vanguard Funds made a huge “splash” in the ETF world this year by shifting the index provider for 22 of their funds (holding over $530 billion in assets) from MSCI Inc. to the FTSE Group — in large part because FTSE has a lower fee structure (aiding Vanguard in maintaining its “low cost provider” status).
Through the world of ETFs, the door has been opened to imagine, create, and “institutionalize” (in an ETF) whatever investment strategy one finds promising. Here is where today’s story begins!
Until the “Bernanke/Tapering”-inspired May/June “swoon”, one of the hottest investment strategies was built upon owning dependable dividend-paying stocks. The three most popular “dividend” ETFs (through the end of May — $40 billion was invested across these three funds) were Vanguard Dividend Appreciation (VIG), iShares Dow Jones Select Dividend (DVY), and SPDR S&P Dividend (SDY). Those who have invested money within these three funds have reason to be pleased.
However, in the “creation process”, every index provider must make choices regarding the characteristics of stocks that it includes and those it excludes. Some of the screening criteria used by one or more of the above ETFs include: a) a minimum of 10 straight years of paying a dividend; b) the fifty highest dividend yielding stocks within the S&P Composite 1500 Index that have increased dividends every year for at least 25 consecutive years; c) daily cash volume greater than $500,000.
Those are solid criteria for selecting stocks that have a sound track record. However, a key question for any investor is: “What does the index exclude… what do I ‘give up’?”
Here is where some current research facts come into play:
A) Ned Davis Research has established that corporations that systematically increase the dividend have produced higher returns over the past forty years than those that do not (or don’t pay a dividend at all);
B) A prime reason Goldman Sachs raised its market outlook for 2013-2014 is its projection that the average S&P 500 dividend growth will be at the 11% level during the period;
C) In light of the importance of dividend growth, WisdomTree notes that, since 2007, over 50% of dividend growth in the S&P 500 has been provided through one stock sector! And yet that sector is severely under-weighted in the three most popular dividend ETFs!
a. Among the three ETFs, DVY has the highest allocation to this sector – but even that is less than half of the sector’s weighting within the S&P Index!
Have you guessed which key sector of “growth” is under-represented in current dividend ETFs? Most likely, the title of this article gave away the answer: technology. Two or three years ago, who would have guessed that Apple (AAPL) would qualify as a “dividend stock”? And yet many technology stocks have accumulated so much cash that they have (collectively) become a growing source of dividend income for investors!
In light of the facts presented above (and in an effort to make money) WisdomTree has jumped into the breech and created an ETF to provide dividend-oriented investors with a “growthy” option within the dividend ETF space: the WisdomTree U.S. Dividend Growth ETF (DGRW).
The “birthday” of DGRW was inauspicious: the day of Bernanke’s fateful testimony mention of “tapering”. Consequently, this month and a half-old ETF has been “baptized” in the fire of market turmoil. Therefore, no chart of performance relative to the three biggest dividend ETFs would be either fair or meaningful. However, the composition and metrics of DGRW are intriguing:
1) Its largest position is AAPL (4.6%) – a stock that won’t qualify for VIG until 2023;
2) Tech stocks account for 20% of DGRW (note that the ETF places a “maximum” allocation per sector limit on itself to ensure diversification – 20%);
3) DGRW screens its portfolio from a potential universe of 1,300 corporations. Within that field, it considers only companies with
a. At least $2 billion in market cap;
b. Company earnings must equal or exceed the dividend;
c. Measure relative earnings growth (forward-looking basis) and quality (determined through a metric giving 50% weight to 3 year return on assets (ROA) and 50% weight to return on equity (ROE);
d. Once portfolio stocks have filtered through these screens, the stocks are weighted by the gross dividends paid ((dividend/share)*(shares outstanding)) – a different weighting than any of the older ETFs.
4) Based on current portfolio composition and prior 12 month metrics, the dividend growth metric for DGRW would be 13.3%;
a. Contrast that with the following—
i. SDY dividend growth at 2.8%
ii. DVY and VIG fall in the 8.0-9.0% range.
5) The top ten stocks (percentage-wise) in DGRW are (in descending order):[4]
a. AAPL
b. Microsoft (MSFT)
c. Proctor & Gamble (PG)
d. Wal-Mart (WMT)
e. Coca-Cola (KO)
f. McDonalds (MCD)
g. Home Depot (HD)
h. Intel (INTC)
i. Altria (MO)
j. PepsiCo (PEP)
6) One sector you do not find among the top eight with DGRW is “Utilities”. They tend not to grow dividends. Remember, emphasis is on dividend growth, not amount of dividend yield.
7) Speaking of “yield”, the current SEC 30-day yield of DGRW is listed at 2.06%.
INVESTOR “TAKE HOME”:
Just in case you didn’t recognize it, everything above from “However, in the ‘creation process…” to here has been an integral part of the intended “take home” for you! What I offer now is a crude, over-simplified “summary”:
DGRW is inherently more “risky” than VIG, DVY, or SDY, because equities with a higher “growth” edge are inherently (over time) more volatile than equities with a long-term track record of higher yield. In addition, you need to know that there is no “back-tested” performance record for the DGRW model.
However, it is clear that the “big three” dividend ETFs have (unwittingly or not) screened their portfolios away from the fastest growing dividend sector – technology. That may prove to be the right choice – only time will tell. However, on an intuitive basis, I think WisdomTree’s approach is well worth consideration. Consider this: VIG has a greater “growth bias” than DVY or SDY, and VIG has outperformed each of the others over the long-term (see the chart below; VIG is in blue). It is reasonable to assume that, over a similar time range, DGRW could outperform all three older ETFs!
In any event, it is interesting that DGRW is the only “mainline” dividend ETF willing to add some AAP(pea)Lto its portfolio. (Yes, the word pun is shameless; but then so am I!)
Disclosure and “final note” for investors: the author owns VIG as well as other dividend-oriented mutual funds, but not DVY, SDY, or DGRW. Although we all wish investing was straightforward and free of “howevers”, the fact is that it is not.
For example, SDY has outperformed VIG over the prior one, two, and five year periods, while DVY outperformed VIG over the prior two-year period. That does not negate the fact that VIG has outperformed the others over the “long haul”. However, the fact is that during a number of shorter timeframes (ie. except for the recent five-day and three-month periods) SDY has outperformed VIG and DVY for much of the past five years.
That is a great lesson for you – reminding you to always be skeptical of what you read and see in print. It can be “true”, and yet still bring you to slightly mistaken conclusions!
[2] Note in the graph below that the ETFs designated in turquoise are “standard” ETFs regulated by the SEC under the Investment Company Act of 1940; those in orange are not registered with the SEC and are regulated by the CFTC.
[3] Source: http://www.icifactbook.org/fb_ch3.html
[4] http://www.wisdomtree.com/etfs/fund-details.aspx?etfid=82
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