Throughout the first part of 2016, Dividend ETFs were all the rage.
Performance was very strong and investors were seemingly piling money into these dividend payers. While the strong performance has leveled off in the latter half of this year, dividend ETFs still seem to be gaining flow (or at least not seeing outflows as could be expected given relative performance).
Some of the recent relative underperformance of dividend payers can be attributed to a somewhat higher interest rate environment. After plummeting over the first half of 2016, rates reversed course and have seen a rather steady uptick since June. As the Federal Reserve looks to raise its target later this year, this rate increase could persist heading into 2017. If that were to happen, dividend ETFs could continue to lag.
Fidelity has taken measures to neutralize this effect of rate increases on relative performance via the release of FDRR – Fidelity Dividend ETF for Rising Rates. In the following, I will dig a bit deeper into this new ETF and how it differs from some of its other Dividend ETF brethren.
To start, FDRR is part of Fidelity’s new suite of Factor ETFs. So as in some of their other names, it will take a multifactor approach in building out exposure. For FDRR, the first three factors include:
- Dividend Yield
- Payout Ratio
- Dividend Growth
While these in and of themselves are not unusual factors to analyze for dividend payers, Fidelity also includes a fourth factor that is the differentiator:
Correlation to 10-Year Treasury Yields
In this, they are identifying companies that have a positive correlation to rising rates (i.e. anticipated to perform better as rates rise) as compared to others in its investible universe.
To go along with this rate correlation factor, another differentiator in FDRR is sector neutrality. One aspect (or complaint depending who you ask) of dividend ETFs is the potential of sizable overweights to sectors such as Utilities. These sectors have shown to outperform when rates decline and vice versa. By neutralizing the sector weights (as compared to the Russell 1000), FDRR looks to add an additional layer of protection against rising rates as compared to other dividend ETFs.
To compare, here is an analysis of FDRR’s sector exposure as compared to the top six US dividend ETFs by size (using exposure data from Bloomberg as of 10/18/2016):
VIG – Vanguard Dividend Appreciation
DVY – iShares Select Dividend
VYM – Vanguard High Dividend Yield
SDY – SPDR S&P Dividend
HDV – iShares Core High Dividend
SCHD – Schwab US Dividend Equity
This first table is an absolute exposure to the GICS sectors:
Conversely, here is a view of each name’s sector exposure as compared to the Russell 1000, which FDRR uses as it base index to determine sector weightings, with the max overweight in green and max underweight in red:
As you can see, compared to these other names, an exposure that stands out is the relative weighting to Technology. Whereas the other dividend names have a lower technology exposure based on the characteristics of the names in the sector, FDRR maintains a higher weighting. Conversely, FDRR maintains a relative underweight to both Utilities and Consumer Staples as compared to the other names.
One last point of differentiation is FDRR’s ability to invest up to 10% of the portfolio in international developed securities. As of today, FDRR has an approximate 5-6% position outside of the US, and this exposure is not concentrated in one country nor specific sector.
A question that could arise is how these factors (both the rate correlation and sector neutrality) affect FDRR’s ability to pay out. The following is a comparison of the dividend yield on the underlying constituents of these same dividend names (note: using the dividend yield on the underlying versus the ETF itself since FDRR has not paid a dividend yet):
Another question that may arise is “Does the rate protection actually work?” While Fidelity has data available to speak to this, the issue is the market has not seen a meaningful period of rising 10-year yields since the late 1980’s.
While there have been pockets of rate spikes here and there, the most sustained period of rising rates has been from May 2003 to June 2007, in which the 10 year slowly climbed about 160bps from 3.4% to 5%. Since the underlying index for FDRR started in the midst of this move (end of 2005), there is not really a great sustained rising rate period to measure FDRR’s effectiveness. While the relative performance during the short spikes may give a glimpse into the differentials, for now the market may have to believe in the theory and rationale versus seeing the raw data in action.
Clayton Fresk is a Portfolio Manager at Stadion Money Management, a participant in the ETF Strategist Channel.
Disclosure Information
Past performance is no guarantee of future results. Investments are subject to risk and any investment strategy may lose money. The investment strategies presented are not appropriate for every investor and financial advisors should review the terms and conditions and risks involved. Some information contained herein was prepared by or obtained from sources that Stadion believes to be reliable. There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change. Any references to specific securities or market indexes are for informational purposes only. They are not intended as specific investment advice and should not be relied on for making investment decisions. The Russell 1000 Index is a stock market index that represents the highest-ranking 1,000 stocks in the Russell 3000 Index, which represents about 90% of the total market capitalization of that index. One cannot invest directly in indexes, which are unmanaged and do not incur fees or charges. Stadion owns long positions in the iShares Core High Dividend ETF (HDV). Founded in 1993, Stadion Money Management is a privately owned money management firm based near Athens, Georgia. Via its unique approach and suite of nontraditional strategies with a defensive bias, Stadion seeks to help investors—through advisors or retirement plans—protect and grow their “serious money.” Contact Stadion at 800-222-7636 or www.stadionmoney.com. SMM-102016-754