(The following white paper on active ETFs from T. Rowe Price was written by Tim Coyne, global head of exchange-traded funds, and James Norungolo, U.S. equity investment specialist.)
The Economy Is Decelerating, Making Dividends More Important
Equity markets have displayed substantial volatility since March. The Federal Reserve, for years friendly toward risk assets, has become a hawkish foe. Fed hikes, plus the resulting economic fallout, have taken benchmark equity indexes from near-record level highs into negative market territory. If there has been a silver lining amid the rout in stocks, it has been the strong performance of active management.
The lesson? When the seas of the market get rocky, it may pay to have someone at the helm. In this regard, investors concerned about volatility persisting may benefit from an allocation to active ETFs focused on quality dividend-paying companies. Dividend growth and earnings growth are two factors that have a significantly negative correlation to the U.S. Manufacturing Purchasing Managers’ Index (PMI), making them attractive given the very real possibility of a U.S. recession. Dividend-oriented strategies also tended to do well in periods of higher inflation. As a consequence, they may be something of a hedge in case the current period of rising prices doesn’t soon abate.
Economic Growth Is Under Pressure
The economy is clearly decelerating, as the Fed keeps hiking interest rates to contain inflationary pressures. Initially thought to be transitory, heightened inflation has proven to be persistent due to a combination of supply chain issues, commodity price inflation, and excess demand from large fiscal stimulus programs.
The pronounced softening of growth is reflected in the yield curve, where the 10-yr./2-yr. spread has become inverted. Given the historical relationship between changes in the yield curve and U.S. PMI data, it is altogether possible that decelerating economic growth could turn into an outright contraction. We’ve already seen two consecutive quarters of negative GDP growth, corporate profit margins are rolling over, and consumer confidence has taken a significant hit. In addition, the housing market, a key driver of economic growth, is showing signs of stress.
Some economic bright spots remain, however. For one thing, the labor market is robust. Unemployment continues to be below 4%, and despite well-publicized layoffs, jobless claims have only risen modestly. It remains a tight market, with demand for workers exceeding the number of people able to fill them. Meanwhile, consumer balance sheets are healthy. Pandemic-related government spending led to higher-than-normal savings for the average individual. Consumers in the lower quintile of income have understandably had to draw down some of these funds to cope with higher prices. On the other hand, those in the upper quintile have ample room to spend more, which may support the economy in the face of its headwinds.
Dividend Payers Have Outperformed
Dividend rates have been on the rise, with 129 S&P 500 Index companies announcing payout increases in Q1 2022. Thus far, payouts to investors are 10% higher versus last year and expected to come in around the high single digit mark next year. The good news isn’t just that dividend rates have been on the rise, but that there is considerable scope for growth based on the S&P 500 dividend payout ratio, which is the ratio of dividends paid relative to the company’s net income. The current ratio stands at 29.2% compared with a historical average of 48.2% (in part because management and boards have deployed cash toward stock buybacks in recent years).
Crucially for investors, the below chart shows that S&P companies that returned profit back to their shareholders in the form of dividends, have recently outperformed S&P companies that didn’t pay dividends.
S&P 500 Dividend Payers Relative to Nonpayers
(Indexed to 100, 1/1/2015) As of March 31, 2022
Past performance is not a reliable indicator of future performance. Source: Strategas.
For illustrative purposes only. It is not possible to invest directly in an index. Data from 1/1/2015 to 3/31/2022, based on relative price returns.
Dividend payers and nonpayers are subsets of the S&P Index.
It’s important to underscore just how committed companies generally are to maintaining and growing their dividends. Once a dividend policy has been established, they are very reluctant to cut payouts to investors. Target is a case in point: In May, its stock dropped by 25% on the back of an earnings miss and deep discounting to clear surplus inventory. The same day it released these negative items, the company also announced it was raising its dividend.
Active ETFs May Do Their Best Work When Markets Are Volatile
As markets have turned volatile, active management has been strong. Data from Morningstar shows that nearly 63% of all actively managed funds have beat their benchmarks since May. This isn’t surprising: Active mandates can add to favored positions in times of weakness while also avoiding stocks that have poor fundamentals (unlike passive vehicles, which often must hold specified securities regardless of investment merits).
Move Aside, Passive: Active ETFs Are on the Rise
In many people’s minds, ETFs are synonymous with passive funds. This is understandable, as the vast majority (94%) of ETF assets are in passive vehicles. However, past is not prologue, and while both categories may continue growing over time, active ETFs are likely to grow at a faster clip in the years to come. According to Morningstar, 60% of new ETFs launched over the past two years have been actively managed. Unlike passive strategies that already cover almost every market segment imaginable, we believe there is still significant scope for active ETFs to expand into more specialized areas like sectors, industries, and narrow themes.
T. Rowe Price Has an Extensive Suite of Active ETFs
T. Rowe Price offers an extensive suite of active equity ETFs. These ETFs provide investors with access to the signature quality that sets our firm apart from the pack: a long, successful track record of active management characterized by solid research and diligent risk management. Investors can reap the benefits of our traditional strategies in an ETF wrapper. T. Rowe Price Active ETFs are convenient, cost-effective, and tax-efficient, making them potentially an attractive choice for individual investors.
Two of our ETFs — the T. Rowe Price Dividend Growth ETF (TDVG) and the T. Rowe Price Equity Income ETF (TEQI) — may be especially appropriate for investors concerned about market volatility and prospects for the economy. Dividend Growth is a large-core mandate, seeking stocks with higher rates of dividend growth than its S&P 500 benchmark. While focused on buying companies at reasonable valuations, this ETF also has exposure to growth-oriented companies. Our Equity Income ETF is more of a value mandate, focused on buying companies with a higher yield than the benchmark Russell 1000 Value Index and that also trade at a lower valuation. Despite their differences, Dividend Growth and Equity Income share a common characteristic, that being a dedication to quality companies that can outperform over the long-term and provide reliable streams of payments to investors along the way.
For more news, information, and strategy, visit the Active ETF Channel.
This ETF is different from traditional ETFs. Traditional ETFs tell the public what assets they hold each day. This ETF will not. This may create additional risks for your investment. For example:
• You may have to pay more money to trade the ETF’s shares. This ETF will provide less information to traders, who tend to charge
more for trades when they have less information.
• The price you pay to buy ETF shares on an exchange may not match the value of the ETF’s portfolio. The same is true when you sell
shares. These price differences may be greater for this ETF compared to other ETFs because it provides less information to traders.
• These additional risks may be even greater in bad or uncertain market conditions.
• The ETF will publish on its website each day a “Proxy Portfolio” designed to help trading in shares of the ETF. While the Proxy Portfolio includes some of the ETF’s holdings, it is not the ETF’s actual portfolio.
The differences between this ETF and other ETFs may also have advantages. By keeping certain information about the ETF secret, this ETF may face less risk that other traders can predict or copy its investment strategy. This may improve the ETF’s performance. If other traders are able to copy or predict the ETF’s investment strategy, however, this may hurt the ETF’s performance.
For additional information regarding the unique attributes and risks of the ETF, please see the Important Information as well as the fund’s prospectus.
Consider the investment objectives, risks, and charges and expenses carefully before investing. For a prospectus or, if available, a summary prospectus containing this and other information visit troweprice.com. Read it carefully.
This material is provided for general and educational purposes only. This material does not provide recommendations concerning investments, investment strategies, or account types. It is not individualized to the needs of any specific investor and is not intended to suggest that any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making. T. Rowe Price Investment Services, Inc., its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.
This ETF publishes a daily Proxy Portfolio, a basket of securities designed to closely track the daily performance of the actual portfolio holdings. While the Proxy Portfolio includes some of the ETFs holdings, it is not the actual portfolio. Daily portfolio statistics will be provided as an indication of the similarities and differences between the Proxy Portfolio and the actual holdings. The Proxy Portfolio and other metrics, including Portfolio Overlap, are intended to provide investors and traders with enough information to encourage transactions that help keep the ETF’s market price close to its NAV. There is a risk that market prices will differ from the NAV. ETFs trading on the basis of a Proxy Portfolio may trade at a wider bid/ask spread than shares of ETFs that publish their portfolios on a daily basis, especially during periods of market disruption or volatility and therefore, may cost investors more to trade. The ETF’s daily Proxy Portfolio, Portfolio Overlap and other tracking data are available at troweprice.com.
Although the ETF seeks to benefit from keeping its portfolio information confidential, others may attempt to use publicly available information to identify the ETF’s investment and trading strategy. If successful, these trading practices may have the potential to reduce the efficiency and performance of the ETF.
ETFs are bought and sold at market prices, not NAV. Investors generally incur the cost of the spread between the prices at which shares are bought and sold. Buying and selling shares may result in brokerage commissions which will reduce returns.
Differences between compared investment vehicles may include investment minimums, objectives, holdings, sales and management fees, liquidity, volatility, tax features, and other features, which may result in differences in performance.
Past performance cannot guarantee future results. All investments are subject to market risk, including the possible loss of principal. As with all equity investments, the share price can fall because of weakness in the broad market, a particular industry or specific holdings. Active investing may have higher costs than passive investing and may underperform the broad market or passive peers with similar objectives. Dividends are not guaranteed and are subject to change. Dividend-paying stocks may lag shares of smaller, faster-growing companies. Also, stocks that appear temporarily out of favor may remain out of favor for a long time.
The specific securities identified and described are shown for illustrative purposes only and do not necessarily represent securities purchased or sold by T. Rowe Price. This information is not intended to be a recommendation to take any particular investment action and is subject to change. No assumptions should be made that the securities identified and discussed were or will be profitable.
© 2022 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
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