INTRODUCTION AND BACKGROUND
Beginning in 2012, I wrote a series of articles that examined a variety of dividend ETFs. My perspective has been to discover whether any are as good or better investments than portfolios carefully constructed of hand-picked dividend growth stocks.
In this 2014 article, I concluded that one ETF – Schwab’s U.S. Dividend Equity ETF (SCHD) – came fairly close to my own concepts of how good dividend growth portfolios should be constructed. I later made a significant investment in SCHD. From reading many comments, it looks like a lot of Seeking Alpha readers have also bought SCHD. Most owners seem pretty happy with their purchases.
Over the past couple of years, another dividend ETF – PowerShares’ S&P 500 High Dividend Low Volatility ETF (SPHD) – has received a lot of mention as a good investment, with many considering it superior to SCHD. It seems fair to say that SCHD and SPHD have emerged among many dividend growth investors as the two best dividend ETFs out there.
I never took a deep dive into SPHD in my original articles, so I want to do that here.
BEFORE WE START
What is “Better”?
Whether you think one investment is “better” than another comes down to your goals. Each individual has his or her own goals in investing. Universal statements that one method is better than another for everyone are false, because they omit the importance of individual goals.
Many investors have a goal like mine, which is to build, over time, an income stream that is sufficient, reliable, and grows faster than inflation. My end game is to live off that income stream in retirement, along with other sources of income.
Many other investors focus on total return. Their goal is to amass, over time, the most wealth possible. Retirement is then funded by that wealth in varied ways, including selling assets.
In most economic writing, the total return goal is often regarded as universal. Indeed it is usually presented as the only sensible goal in personal finance. It is presumed that every investor invests solely to become as wealthy as possible.
So upfront, let me state that my perspective is largely based on the goal of optimizing income over a long time frame. Many dividend growth investors also have this as their primary goal. We recognize that total return will happen too, but it is not our central focus.
What is “Passive”?
Most ETFs are called “passive” investments, but this is misleading. With SCHD and SPHD, as with most ETFs, there are two layers of management.
In the first layer, an index provider supplies the index upon which the fund is based. This is where most of the management of the portfolio takes place.
Within the index is where you will find:
The basic mission
How stocks are selected
How many stocks the portfolio contains
How the portfolio is managed
Whether the portfolio is cap-weighted or weighted in some other way (“smart beta”)
How often the portfolio is reviewed
How often the portfolio is reconstituted
Whether the portfolio is periodically rebalanced
The second layer of management comes from the ETF provider. Most ETFs simply “seek to track” the underlying index’s performance. Because the fund itself does not select stocks or do any of the other active stuff that is done at the index level, ETFs are usually called “passive” investments.
In my opinion, that’s marketing-speak. Do not lose sight of the facts that
Stock selections are being made and periodically changed, and
The composition and weighting of the fund’s components changes over time.
That is why turnover rate of “passive” ETFs is not zero.
With that background, let’s get started.
SCHWAB U.S. DIVIDEND EQUITY ETF
Note: This is a complete update of my original analysis of SCHD.
Sources of Information: Schwab, Morningstar, S&P Dow Jones Indices
Year Introduced: 2011
Fund total net assets: $5.45B
Trailing 12-Month Yield: 2.9%
Expense ratio: 0.07%. I believe that SCHD’s 0.07% expense ratio makes it the cheapest dividend ETF available. According to Morningstar, the median fee for large-value funds is 0.90%.
Turnover: 22%. An ETF pays transaction costs, such as commissions, when it buys and sells securities. A higher portfolio turnover rate may lead to higher transaction costs and result in more taxes when shares are held in a taxable account. These costs, which are not reflected in annual fund operating expenses, reduce the fund’s performance.
ETF Summary: Schwab states that SCHD offers a convenient, low-cost way to capture the performance of high dividend yielding U.S. stocks issued by companies with a record of consistent dividend payments. It also says that SCHD provides the potential for both current income and capital appreciation, and that it may add diversification to an income stream.
ETF Methodology: SCHD seeks “to track as closely as possible, before fees and expenses, the total return of the Dow Jones U.S. Dividend 100™ Index.” That index comes from S&P Dow Jones Indices, which bills itself as the world’s largest resource for index-based innovation, data and research.
S&P Dow Jones Indices was formed from a merger in 2012, which post-dates the introduction of the underlying index for SCHD. I found no evidence that the merger impacted the index’s basic philosophy, mission, or implementation.
The stated objective for the index is to measure the performance of high-dividend-yielding stocks in the U.S. with a record of consistently paying dividends, selected for fundamental strength relative to their peers, based on financial ratios. The index’s ticker symbol is DJUSDIV.
The index contains 100 stocks, and it was launched on August 31, 2011. The index is a selection of stocks culled from the Dow Jones U.S. Broad Market Index, which includes the 2,500 largest U.S. stocks based on full market capitalization. REITs are excluded from the index universe.
The distillation process has several steps. First, stocks in the universe are subject to screens for dividend payment consistency, size and liquidity. Passing stocks must have a minimum 10 consecutive years of dividend payments.
Then they are ranked in descending order by indicated annual dividend yield (ignoring special dividends). The top half of the ranked list is eligible for selection.
Then the stocks are ranked again on several characteristics:
The four rankings are equal weighted to create a composite score, and the eligible securities are ranked yet again based on this composite score. The 100 top-ranked stocks by the composite score are selected to the index.
The portfolio is reviewed annually at the end of December. To reduce turnover, S&P DJI applies buffer rules to favor current constituents during the annual review.
Constituent stocks remain in the index as long as they are among the top 200 by the composite score.
New stocks are added to the index based on their rankings until the constituent count reaches 100.
If two new candidates have the same composite score, the one with the higher dividend yield is selected.
As to weighting, stocks are weighted quarterly based on market capitalization, with provisos that no single stock can represent more than 4.5% of the index and no single industry, as defined by a proprietary classification system, can represent more than 25% of the index. Re-weightings take place at the time of index construction, annual rebalancing, and quarterly updates.
So you can see where the 22% turnover comes from in SCHD, which is nominally passive. It comes from the underlying index:
Rules about stocks that can be in the index.
Annual review, reconstitution, and rebalancing (end of March).
Quarterly updates. This includes re-weighting. Also, a subjective review has been added under which a stock may be removed if the Index Committee determines that the company’s dividend program is at significant risk.
Immediate removal if a company is delisted, files for bankruptcy, or eliminates its dividend.
Spin-off companies are added to the index, but then removed if they are determined to be ineligible for continued index inclusion.
As stated earlier, SCHD holds 100 stocks. Because of the index’s screens, SCHD’s portfolio is high quality. 71% of the stocks have a wide moat and another 23% have a narrow moat rating. Only 6% have no moat. Morningstar rates the portfolio’s blended financial health as A- and its profitability as B-.
The types of stocks in SCHD are shown by the following graphic from Morningstar. The fund is mostly invested in large (and giant) capitalization stocks that fit Morningstar’s definition of the value style. All holdings are U.S.-based.
Here are the sector weightings:
Notice that SCHD holds no real estate (REITs), little in financial services, not much energy, and almost no utilities. On the flip side, it is heavy in consumer stocks (both cyclical and defensive), industrials, and technology.
Proportion of fund in ten largest holdings: 45%
Largest holdings: This graphic shows the top 10 holdings in SCHD.
Distributions: This display is from Morningstar.
SCHD’s 3-year compound annual dividend growth rate through the end of 2016 is 11.9% per year.
As with all of the ETFs that I have examined, SCHD’s quarterly payments are erratic, moving both up and down during the course of each year. Meaningful comparisons can only be made on an annual basis.
If SCHD were a company, it would qualify for David Fish’s Dividend Champions document (“CCC”). 2016 was its 6th year of increasing dividends if you count its start-up year (2011) as Year 1.
Total performance: Here is how Morningstar depicts SCHD’s total performance since inception.
SCHD has trailed SPY over the past year, and is about about a percent less annualized than SPY over the past 3- and 5-year periods. (By the way, I confirmed with other sources that these are “total returns chocolate” with dividends reinvested by cross-checking with ETFreplay, despite the confusing “Price” label that Morningstar places on the line items.)
POWERSHARES S&P 500 HIGH DIVIDEND LOW VOLATILITY ETF
Sources of Information: Schwab, Morningstar, PowerShares
Year Introduced: 2012
Fund total net assets: $3.00B
Trailing 12-Month Yield: 3.86%
Expense ratio: 0.30%. According to Morningstar, the median fee for large-value funds is 0.90%.
Turnover: 50%. Personally, I consider this high for any portfolio except maybe a day trader or swing trader.
ETF Summary: PowerShares states that SPHD aims for high dividend yields and low volatility. The index provider states that the index combines two well-known investing themes: low volatility and income. The goal of the index is to provide a selection of high-yield stocks from the S&P 500 and use price volatility as a screen to avoid dividend traps. “Historically it has been found that high price volatility is a good indicator of companies in stress.”
ETF Methodology: SPHD “seeks investment results that generally correspond (before fees and expenses) to the price and yield of the S&P 500 Low Volatility High Dividend Index.”
The index is provided by the same company as SCHD’s index. The fund was introduced the same year as the merger that produced S&P Dow Jones Indices.
The stated objective for the index is to measure the performance of the 50 least-volatile high dividend-yielding stocks in the S&P 500. “The index is designed to serve as a benchmark for income-seeking investors in the U.S. equity market.” The index’s ticker symbol is SP5LVHDT.
The index contains 50 stocks, and it was launched on August 31, 2011. The index is a distillation of the S&P 500.
The distillation process has several steps that are very straightforward.
Stocks in the S&P 500 are ranked in order of their trailing 12-month yields. The top 75 stocks are selected.
The number of stocks from each GICS sector is capped at 10.
From the 75 stocks, the 50 with the lowest realized trailing one-year volatility (252 trading days) are selected.
The 50 stocks are weighted by yield. The weight for each stock is capped at 3%, and the weight for each sector is capped at 25%.
The portfolio is rebalanced twice per year in January and July.
The 50% turnover probably comes mostly from the one-year volatility rankings. My guess is that those move around a lot.
As stated earlier, SPHD holds 50 stocks. From the following Morningstar graphic, the portfolio is not as high-quality as SCHD’s portfolio. Just 23% of the stocks have a wide-moat rating and another 51% have a narrow moat. 26% have no moat. Financial health is rated as B+ and profitability as C.
The types of stocks in SPHD are shown by the following graphic from Morningstar. The fund is mostly invested in large capitalization stocks with an extreme tilt toward Morningstar’s definition of the value style, verging over into “deep value.” All holdings are U.S.-based.
Here are the sector weightings:
Notice that SPHD, in contrast to SCHD, holds a significant stake in real estate (REITs), which is its 2d-largest sector. It also holds a massive stake in utilities. It holds relatively little in financial services, energy, and healthcare.
Proportion of fund in ten largest holdings: 26%
Largest holdings: This graphic shows the top 10 holdings in SPHD.
Distributions: This display is from Morningstar.
SPHD’s 3-year compound annual dividend growth rate through the end of 2016 is 13.4% per year.
SPHD pays monthly instead of quarterly. As with all of the ETFs that I have examined, its payments are erratic, moving both up and down from month to month. Meaningful comparisons can only be made on an annual basis.
If SPHD were a company, it would just qualify for David Fish’s Dividend Champions document (“CCC”). 2016 was its 5th year of increasing dividends if you count its start-up year (2012) as Year 1.
Total performance: Here is how Morningstar depicts SPHD’s total performance since inception.
SPHD has trailed SPY over the past year but has beaten it over the past 3-year period.
HEAD TO HEAD
Most readers are probably interested in a head-to-head comparison between these two popular dividend growth ETFs, so I have put together the following table to compare them on various metrics.
I have taken the liberty of coloring some cells to indicate advantages to one or the other. Obviously, the colors represent my opinions. Everyone should interpret the raw data for themselves.
I hope that you found this analysis interesting, and I look forward to an active comment stream.
Disclosure: I am/we are long SCHD, SPHD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.