CDC: Volatility-Weighted Dividend Strategy Delivering Alpha In 2022 (NASDAQ:CDC)

The VictoryShares US EQ Income Enhanced Volatility Weighted ETF (NASDAQ:CDC) combines fundamentals-based criteria and a quantitative approach in an effort to deliver superior risk-adjusted returns. The strategy selects dividend-paying stocks that are profitable with holdings further screened by their risk profile. The method has worked with the fund delivering a positive return this year in contrast to the broad market selloff. Impressively, CDC has also outperformed the S&P 500 (SPY) over the past five years highlighting the allure of the strategy that is proving to work in various market environments. Income investors will also be attracted to the fund’s monthly dividend which currently yields 2.7%.

What is the CDC ETF?

CDC technically tracks the “Nasdaq Victory US Large Cap 500 Volatility Weighted Index”. From a universe of about 500 US large-cap companies, the underlying index screens for the top 100 yielding stocks with positive earnings over the past year. What makes the fund stand out from the typical “dividend ETF” is the alternative weighting methodology that ranks the holdings based on their standard deviation over the last 180 trading days. This means that stocks with low volatility and generally “lower risk” gain importance in the portfolio with a larger relative allocation. The result is a portfolio concentrated among overall high-quality companies and a defensive tilt.

With 100 holdings, the current portfolio has a 26% allocation to the utility sector which is consistent with the low volatility strategy. That said, there is some exposure to all sectors including a 17% weighting in financials and 15% in consumer staples. Among the top holdings, several market leaders like PepsiCo Inc (PEP), Johnson & Johnson Co (JNJ), and utility giant Southern Co (SO) each have a 1.6% weighting in the fund. An important point here is that the index and ETF reconstitute bi-annually ensuring the weighting methodology reflects current market trends.

CDC Performance

Since the focus is on low volatility stocks, CDC has been invested among outperformers considering the more generalized market weakness. Indirectly, the strategy has a momentum component because it effectively rotates out of poor-performing stocks that have been volatile while also limiting exposure to companies with fundamental weaknesses like negative earnings or dividend suspensions.

As mentioned, the strategy has paid off with CDC up about 1.5% year to date in 2022, in contrast to the 15% decline in the S&P 500. The fund’s allocation towards utilities and consumer staples, while avoiding technology and industrial names, has proven to be the sweet spot for delivering alpha.

We also highlight how CDC has outperformed a couple of comparable funds like the Invesco S&P 500 Low Volatility ETF (SPLV) which features a similar volatility-weighted strategy, but not the dividend income focus. There is also the SPDR S&P Dividend ETF (SDY) which simply invests across the 80 highest yielding S&P 500 stocks without a distinction for risk metrics. In this case, CDC is up 1.5% year-to-date, compared to a -3.3% decline in SPYD and -5.2% decline from SPLV.

With data going back to the fund inception date in July 2014, CDC has managed to deliver a cumulative return of 154% which is above the 137% gain from SPY, 119% from SDY, and 116% from SPLV. To be clear, the performance spread differs by the specific lookback period. From the chart below there was a period around 2019 when CDC was lagging behind this comparison group based on the particular market environment at the time. Much of the outperformance in CDC has come over the past year, particularly in the current market environment defined by extreme volatility.

Finally, we note that CDC also offers the highest dividend yield in the group at 2.75%, slightly above SDY at 2.7%, and well above SPLV at around 1.8%. CDC and SPLV maintain a monthly distribution schedule while SDY and SPY have quarterly dividends.

CDC ETF Price Forecast?

The attraction of the CDC ETF is its balanced approach between a fundamentals-based screening and quantitative investing methodology. In the current market environment, the fund represents a relatively conservative strategy with generally lower market risk. If equities as an asset class are going to continue selling off, we expect CDC to outperform, at least with narrower losses.

On the other hand, it’s important to recognize the areas of the market where CDC is underweight, particularly in “growth” stocks and the technology sector. If there is a scenario where risk sentiment improves materially going forward, speculative non-dividend paying stocks would likely gain momentum, and CDC should lag more diversified equity funds to the upside.

Signs of the economy slowing with persistently high inflation with climbing interest rates into a Fed tightening cycle are all headwinds facing stocks. The ongoing Russia-Ukraine crisis adds another layer of risk to the outlook. Our baseline is to expect continued volatility without any quick fixes for the foreseeable future. Still, there is room to take a more constructive view. With the S&P 500 down by 15% from its previous high, the silver lining is that market valuations have pulled back from what may have been exuberant expectations at their peak.

There is a case to be made that many of the challenges facing the market have been digested over the last several months and mostly priced in at the current level. Better than expected outcomes going forward can be positive for stocks leaving the door open for a bullish case through the second half of 2022. By this measure, CDC captures a moderately bullish outlook on stocks. The fund is positioned to benefit from upside while limiting downside risk compared to broad-market funds.

Final Thoughts

CDC has emerged as an outlier with a positive return in 2022 amid a historically difficult trading environment. We like CDC as a high-quality fund and a good core portfolio holding option for equity exposure. The data speaks for itself with the VictoryShares US EQ Income Enhanced Volatility Weighted ETF highlighting the value of its strategy.