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Dividend-paying stocks usually get punished in a rising rate environment. That rationale is that as rates on fixed income securities rise, they become more attractive to income-seeking investors than the more volatile common stocks of dividend-paying companies. So naturally, investors sell their dividend-paying stocks in favor of bonds that not only provide more stable prices, but are also higher on the priority list within a company’s capital structure.
The same does not hold true for dividend growth stocks. That is, for those companies that have historically raised, and more importantly, are expected to continue to raise dividends in the future. Companies that are expected to increase their dividends tend to perform better when rates rise because even though fixed income starts looking more attractive in relative terms, the potential for dividend growth gives dividend growth stocks an edge over those whose dividends are expected to remain stable.
While history may not be a good predictor of future returns, company dividend policies are sacred. A company that adopts a certain dividend policy and then deviates from that policy is likely to alienate many of the dividend-seeking investors that favor the stock. So in this case, we might be able to look at history to identify which companies have a tendency to raise their dividend and determine with some level of certainty that they are likely to continue to raise dividends in the future.
ProShares S&P 500 Dividend Aristocrats ETF
The ProShares S&P 500 Dividend Aristocrats ETF (NOBL) has provided attractive returns to investors over the last decade and has outpaced the growth of the S&P 500 Index with much lower volatility. The investment objective of NOBL is to track the investment results of the S&P 500 Dividend Aristocrats Index and is the only exchange traded fund (ETF) that tracks this index.
The index only includes S&P 500 companies that have raised their dividends for 25 consecutive years, which typically include companies with stable profit and growth, financial stability, and high-quality earnings. If a company does not raise their dividend in any given year, they are dropped from the index and cannot be added until the dividend growth streak is reestablished after 25 years.
The index has comfortably outperformed the S&P 500 Index consistently, which has helped NOBL gain traction among other dividend-focused ETFs in the market. The outperformance of the underlying index in comparison with the S&P 500 Index has also come at a lower volatility as well, and this attractive risk-return profile has been embraced by many investors over the last decade.
(Source: ProShares)
(Source: Fact Sheet)
Since its inception in 2013, NOBL has provided a cumulative return of 66%, which comes a notch below the return of the S&P 500 Index over the same time period.
(Source: Fact Sheet)
The current composition of the portfolio is naturally aligned toward large-cap and mega -cap stocks and more likely to be tilted towards value than growth.
Portfolio weights by market capitalization
(Source: Morningstar)
Top 10 holdings of the fund account for 20% of the total portfolio, and the fund is overweight on consumer staples and industrial sectors. The significant exposure to consumer staples is expected to provide the fund with the ability to earn attractive returns to investors even when economic growth lags. Overall, the portfolio of the fund is made up of stocks from a variety of sectors, and I believe the portfolio is diversified to the extent where a dividend investor should feel comfortable.
One drawback that can be seen from the composition of the portfolio is the relatively meager exposure to growing sectors such as the information technology sector. The portfolio screening process does not permit NOBL to hold these high-growth stocks in the portfolio, which might become an obstacle in providing better-than-market performance when economic growth continues to disrupt based on technological innovation.
Portfolio composition
(Source: Fact Sheet)
The expense ratio of 0.35% falls in line with that of the category average, which stands at 0.36%.
(Source: Summary prospectus)
NOBL yields just over 2% at the current market, which is not an exuberant yield by any means, but the emphasis should be placed on the risk-adjusted return of the fund. NOBL exposes investors to a significantly lower risk than holding individual stocks with high dividend yields, whether it be large-cap stocks or not.
(Source: Morningstar)
Since its inception, NOBL has traded with a dividend yield close to 2%, which might be a reasonable indicator in identifying the valuation implications as well.
Historical dividend yield
(Source: Seeking Alpha)
From a valuation perspective, NOBL is trading at a forward earnings multiple of 17, which is significantly lower than the current S&P 500 P/E of close to 21.
(Source: Morningstar)
Portfolio Construction Strategy
In order to assess the portfolio construction strategy of NOBL, investors need to identify how the underlying index, the S&P 500 Dividend Aristocrats Index, picks stocks. As the main investment objective of the fund is to track this underlying index, the investment strategy of the fund relies heavily on the strategies implemented by the underlying index.
The underlying index selects securities from the S&P 500 Index, which leaves a wide variety of dividend-paying stocks to choose from. However, the investment strategy of the index limits the available number of stocks to invest in by a significant amount.
To start with, the index includes stocks that have been able to grow their dividends consecutively for the last 25 years. Understandably, this limits the number of stocks available to invest in and reduces the level of diversification possible within the fund. On the other hand, the index’s criteria limit inclusion to only the most financially stable companies.
The index is designed to contain at least 40 such stocks at any time. However, in the event of a failure to identify 40 stocks that meet the above criteria, the index will invest in companies that have a shorter period of dividend growth.
A noteworthy strategy of the index is to limit its exposure to a single sector to 30% of the portfolio, which I believe provides a hedge against industry concentration risk for investors. It is common to find dividend growth stocks in a select few sectors, and the failure to cap the industry weights could have resulted in a very high concentration in one sector.
Comparing NOBL to SPY
As described earlier, NOBL comprises a subset of the S&P 500 Index, but with the caveat that it only invests in companies that have raised their dividend for 25 consecutive years. That will naturally lead to some underlying differences in the portfolios of each. To make this comparison, we will use the SDPR S&P 500 ETF (SPY) as a proxy for the S&P 500 index.
Fund Overview and Returns
As the table and chart below indicate, NOBL is much smaller than SPY and has an expense ratio of 0.35% compared to 0.09% for SPY. It does, however, have a higher dividend yield than SPY with a yield of 2.15%. This is not surprising considering NOBL invests in companies whose dividends have increased for 25 consecutive years.
As for performance, the chart below shows the trailing period returns for both ETFs. The five-year rolling return, which is the longest comparable period shown, indicates that performance is quite similar, where NOBL has outperformed SPY by 10bps annually.
As previously mentioned, it is likely that NOBL would exhibit lower volatility than the broader index because of how it selects stocks for inclusion. The slightly lower standard deviation of 10.67% compared to 11.47% for SPY results in a higher Sharpe Ratio for NOBL (Note: A higher Sharpe Ratio indicates a higher risk-adjusted return for each unit of risk taken).
We also see that NOBL has a lower Beta to the S&P 500, a lower drawdown, and a higher up/down capture ratio. All of these indicators suggest that over the period analyzed, NOBL has outperformed SPY on a variety of metrics.
Sector Allocation
One notable difference between the two ETFs is the sector exposure of each. Since NOBL only invests in companies with a history of dividend growth, it is not surprising that it would have lower exposure to sectors with companies that tend not to pay dividends. A perfect example is Technology, which is noticeably absent from NOBL, but has a 23% exposure within SPY.
The two sectors with the highest exposure in NOBL are Industrials and Consumer Defensive stocks.
Equity Fundamentals
NOBL’s holdings make up comparable ROE, but currently have a slightly higher PE ratio than the broader index represented by SPY. The companies in the portfolio also have slightly lower earnings growth and revenue growth projections than those in SPY, likely due to the exclusion of Technology as well as the different mix of sectors within the fund.
Our Take
NOBL provides an attractive opportunity for dividend investors as a core holding. It can be used as the main exposure to large-cap blend or value, or used in conjunction with another position such as SPY. With a beta of 0.86 to the S&P 500, it would provide for additional diversification to a pure large-cap exposure.
We would add exposure to NOBL during times of economic uncertainty, potential rate increases, and slower growth cycles; however, we would limit our large-cap exposure if we have a favorable outlook on higher growth sectors like Technology.
We have included NOBL within our Core Holdings because we believe it can be a stand-alone position within a portfolio for portfolios looking for US large-cap exposure. We have also touted the S&P Low Volatility Index ETF (SPLV) as another stand-alone US large-cap play.
You can’t go wrong with either one and now that the Fed is likely to pause its pace of rate increases, investors need not fear the impact of rising rates on dividend-paying stocks.
The Income Strategist
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Disclosure: I am/we are long NOBL. 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.
Additional disclosure: This article is meant to identify an idea for further research and analysis and should not be taken as a recommendation to invest. It does not provide individualized advice or recommendations for any specific reader. Also note that we may not cover all relevant risks related to the ideas presented in this article. Readers should conduct their own due diligence and carefully consider their own investment objectives, risk tolerance, time horizon, tax situation, liquidity needs, and concentration levels, or contact their advisor to determine if any ideas presented here are appropriate for their unique circumstances. Furthermore, none of the ideas presented here are necessarily related to NFG Wealth Advisors or any portfolio managed by NFG.
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