The Dividend Disconnect

In a number of recent articles, I have been covering strategies that have outperformed since the '07 market peak. Of the eleven factor tilt strategies where these articles have demonstrated the generation of alpha over this period, four strategies have been dividend-focused strategies. Those strategies - the S&P 500 Dividend Aristocrats (NOBL), the S&P 500 Low Volatility High Dividend ETF (SPHD), the Russell 2000 Dividend Growers ETF (SMDV), and the S&P MidCap 400 Dividend Aristocrats (REGL) all posted outperformance in both the stock market drawdown and the subsequent recovery.

Source: Bloomberg

These dividend-focused strategies have focused on dividend growth, low volatility, and/or capturing size premia. The outperformance of these dividend strategies stands in stark contrast to the performance of pure large-cap strategies focused solely on dividend yield. While many point to falling interest rates as a tailwind for dividend strategies, the S&P 500 High Dividend Index, which features the 80 highest dividend yielding stocks in equal weights, has actually lagged the market since the 2007 peak. Below I have graphed the S&P 500 High Dividend Index (SPYD) versus the S&P 500 from the 2007 peak.

Source: Bloomberg

Since the 2007 peak, the 80 highest dividend yielding stocks in the S&P 500 have slightly underperformed the broad market. This total return includes reinvested dividends. On a price return basis, the high dividend yield strategy lagged the broad market by an additional 2-3%.

From the first graph, we know that among the 75 highest dividend yielding stocks, a rebalanced portfolio of the 50 with the lowest realized volatility (the S&P 500 Low Volatility High Dividend Index) has generated 10.69% annualized returns over this period. There is undoubtedly a lot of overlap between that index and the pure yield-focused index, but the low volatility-tilted index returned nearly 3% more per year. That would have added up to a large cumulative differential over a dozen years.

For Seeking Alpha readers, I pulled down the 80 current constituents from the S&P 500 High Dividend Index and the 50 current constituents from the S&P 500 Low Volatility High Dividend Index. Below I have listed the companies that were not included in the lower volatility version. The number is actually 35 companies currently given the different rebalancing dates of the two indices. While the population of these two indices changed over the last dozen years, I wanted to examine what types of constituents might have caused a large discrepancy in the return profile of these two indices.

I have sorted the list above by realized volatility in the far right column, the screening mechanism that separates the two indices from a pure yield focus. Note that 8 of the 10 most volatile companies have generated meaningfully negative returns this year. Among these laggards is a number of brick-and-mortar focused retailers. Companies with secular headwinds (the aforementioned traditional retailers, disk drive manufacturers, wireline companies), cyclical concerns (automakers, oil field sevices), and unique idiosyncratic risk (California wildfires) populated this list.

On average, these companies have produced a decent 12% total return year-to-date, but this still meaningfully lagged the 20%+ return for the broad market. The current dividend yield of 4.8% is certainly above market, but that yield has not translated into higher total returns for this cohort. This performance echoes the long-term look at the impact of dividend yields and stock returns. In The Graph All Dividend Investors Should See, I noted that dividend-payers outperform non-dividend payers, but that the highest dividend cohort has actually delivered sub-trend average returns with above average volatility. The performance of these strategies since the 2007 peak should remind investors that chasing the highest dividends can be harmful to portfolio performance. After all, dividend yields can rise for growing dividendsor falling share prices. However, well structured dividend strategies, like those referenced in the beginning of the article, can generate the structural alpha we are seeking.

Disclaimer:

My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon.

Disclosure:

I am/we are long SPHD,NOBL,SMDV,REGL,SPY.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.