Dividend growth has been a popular strategy that many investors have adopted as a way to boost portfolio returns, but many dividend funds rely on hindsight and are backward looking. Alternatively, investors may consider a forward-looking dividend exchange traded fund strategy that tries to target companies more likely to raise dividends while diminishing exposure to those likely to cut payouts.
On the recent webcast, Why Dividend Growth Strategies Continue to Rally, Eric R. Ervin, Co-Founder and CEO of Reality Shares, argued that given the extended bull Treasuries market that has pushed yields on benchmark 10-year notes back down to 1.5% and the ongoing eight-year stock market rally, investors should consider dividend growth strategies as a way to add value to an investment portfolio in the current challenging market environment.
Kenny Polcari, Managing Director of O’Neil Securities, outlined some current market themes, such as questions over the upcoming presidential election and ongoing market fears and swings, that have weighed on investment sentiment. Furthermore, after the Brexit-induced correction, we are breaking toward new record highs.
The focus on quality dividend payers has been a prevailing theme to help diminish portfolio drawdowns during periods of heightened uncertainty. In a survey of financial advisors attended the webcast, 70% said they plan on raising their dividend ETF exposure while only 11% aren’t look at increased dividend positions.
However, many of the most popular dividend growth funds are based on data of prior payouts, tracking companies that have shown a history of yield growth. There is no guarantee that history will stay the same.
“Most existing strategies suffer from simplistic ‘hindsight’ approach,” Ervin said. “This leaves them vulnerable to include the very stocks they are trying to avoid.”
SEE MORE: A Forward Looking Dividend ETF Strategy
For instance, Ervin pointed out that the benchmark S&P 500 Dividend Aristocrats Index holds about 50 to 60 components, but during the financial crisis, 13 of the so-called dividend aristocrats cut or eliminated their dividends. Additionally, the benchmark NASDAQ Broad Dividend Achievers Index saw 55 of their 280 components cut dividends during the financial crisis.
“We wanted to build a more robust forward looking model to sole for this problem,” Ervin said.
[related_stories]Specifically, Reality Shares has a suite of ETFs that focus on U.S. companies expected to raise dividends ahead, including the Reality Shares DIVCON Leaders Dividend ETF (BATS: LEAD), Reality Shares DIVCON Dividend Defender ETF (BATS: DFND) and Reality Shares DIVCON Dividend Guard ETF (BATS: GARD).
The DIVCON ETF suite tracks companies based on the dividend growth of the broad market, and also those stocks most likely to increase their dividends while avoiding and even sometimes capitalizing on those stocks more likely to reduce dividends.
Specifically, the DIVCON dividend health rating system tries to forecast and rank companies’ ability to increase or decrease dividends in the next 12 months by evaluating each firm based on expected dividend growth, free cash flow, earnings per share growth, recent dividend actions, buybacks and repurchases, Bloomberg fundamentals and Altman z-scores. Each company is scored into one of five categories, with DIVCON representing the healthiest and DIVCON showing the weakess.
SEE MORE: A Different Type of Dividend Growth ETF
Ervin pointed out that 97% of DIVCON5 companies have raised dividends from January 2001 through December 2015. Moreover, components in the DIVCON Leaders Dividend Index did not cut dividends during the financial crisis.
“The true power of the DIVCON model lies in its ability to distinguish high quality companies from low quality companies,” Ervin added.
Financial advisors who are interested in learning more about dividend strategies can watch the webcast here on demand.