Given the current near-zero interest rate environment, there has been a significant movement that has taken yield-hungry investors in a number of directions to secure meaningful yields, including the ultra-popular dividend strategy. Michael Akins, Lead Portfolio Manager for ALPS ETF Trust and initial creator of the SDOG license, recently took the time to discuss the thought behind the compelling “Dividend Dog” strategy [see Free Report: How To Pick The Right ETF Every Time].
ETF Database (ETFdb): What was the inspiration behind creating the Sector Dividend Dogs ETF (SDOG)?
Michael Akins (MA): The ultimate goal when we set out to design a dividend ETF was to address what we perceived as a trade-off that existed in the current High Dividend ETF space. Essentially, investors had a decision between two types of dividend ETFs: (1) fairly diversified, modest-yielding, dividend “growth” portfolios – these are going to be the ETFs that track indexes that have very stringent screens on consistency and growth and often result in a yield that is only modestly higher the broader market; and (2) higher yielding but largely undiversified, dividend “value” portfolios – these portfolios are likely to have large defensive sector tilts (utilities, staples, etc.), and many times, because they often weight by yield, may have a large percentage of the portfolio in their top 10 holdings.
What we did to address this trade-off was to expand the original “Dogs of the Dow” strategy to each sector of the S&P 500 to create a portfolio that retained the high dividend yield and deep value characteristics of the Dow Strategy but with much better sector diversification across a broader universe of stocks [see Monthly Dividend ETFdb Portfolio.
ETFdb: What is the objective of the fund and how does it go about accomplishing it?
MA: SDOG has three main objectives; deliver a portfolio that (1) provides a significantly higher dividend yield than the broad equity markets, (2) achieves diversification at both the security and sector leve,l and (3) deliver a deep value portfolio with the potential to provide attractive returns through various market cycles.
We believe SDOG accomplishes these goals by creating a portfolio that annually selects the five highest-yielding securities in each of the 10 GICS sectors in the S&P 500 - what we define as “sector dividend dogs.” Taking the three objectives separately, here’s what we believe you’ll find [see Visual History Of The S&P 500]:
(1) High yield is achieved by starting with a smaller, quality universe of stocks in the S&P 500 and making yield the primary screen. This allows us to not screen away good income opportunities through multiple layers of screens such as longevity, consistency, growth and sustainability as is the case with many other dividend ETF indexes that start with a very large beginning universe.
(2) Diversification is essentially hard wired into our index methodology as a result of isolating the yield screen on a sector-by-sector basis and then equally weighting all 50 securities, providing a portfolio that has 2% in each stock and 10% in each sector
(3) And finally, the most important part of any equity portfolio, the potential for attractive total return comes primarily through two portfolio themes. First, Dogs Theory suggests that the reason certain securities are yielding higher than their peers is because the stock has been out of favor and, to the extent the companies continue to pay their dividends, eventually market forces will bring the yield back in-line with their peers providing additional price appreciation. It is this part of the strategy where starting with a smaller, quality universe like the S&P 500 is critical since the strategy works best when the companies continue to pay or even increase their dividends.
If you look back at the favorable and unfavorable dividend actions on the S&P 500 vs. non S&P 500 companies over the past 10 years you’ll find that the S&P has a very rich dividend history (see chart provided). Most importantly to our strategy is that with the exception of 2008 and early 2009 where every major bank was required to reduce or eliminate their dividend, a very small percentage of companies’ quarterly dividends were reduced or eliminated [see 101 High Yielding ETFs For Every Dividend Investor].
While our index methodology will likely pick up some of these outlier securities that do have negative dividend actions, the number of companies that will continue to pay or even increase their dividends–the value opportunities–have historically far exceeded those with negative dividend actions, or the “value traps.” And the second piece of the total return is accomplished through having equal allocations to all sectors, allowing the opportunity to participate in all market cycles (not just defensive portfolios like many of our peers) while avoiding bubbles in any one sector (tech bubble in early 2000s or financial crisis in 2008 where both respective sectors were by far the largest weighting in the S&P 500):
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ETFdb: Aside from generating current income, what else might investors find appealing about adding SDOG to their portfolios?
MA: I think I’ve outlined the major benefits of SDOG, but if I was going to highlight one major theme it would be SDOG’s equal sector methodology, which allows investors to have a deep value strategy while still gaining exposure to all sectors of the market. The reality is that there are dividend value opportunities in all sectors, but value in a consumer discretionary company will likely look very different than say a consumer staples company, and when screened across a broad universe of stocks the consumer discretionary company is likely to get left out. SDOG is able to identify these opportunities because the dividend screen is isolated to each sector rather than applied equally across an entire universe. This allows investors to achieve high equity yield in a yield starved environment, but doing it in a manner that doesn’t focus solely on lower beta, defensive portfolios that may likely give up significant upside in a cyclical bull market.
Bottom Line: Today’s low-rate environment poses a significant challenge for investors and ETF issuers alike. On the product development front, issuers continue to respond to investors’ needs as seen with the latest wave of dividend-focused ETFs. For those looking for a new way to tap into the ultra popular dividend strategy, ALPS’s Sector Dividend Dogs ETF (SDOG) is certainly a compelling option.
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Disclosure: No positions at time of writing.
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