RDVY: Why I’m Downgrading The Rising Dividend Achievers (NASDAQ:RDVY)

Investment Thesis

The First Trust Rising Dividend Achievers ETF (RDVY) has proven it can perform well in low-interest-rate environments, but it’s also been succeeding so far this year as rates are expected to rise and as the market corrects. This 50-stock fund is overweight both the Technology and Financials sector, has a 19.29% forward EPS growth rate, and a very attractive 15.47x forward price-earnings ratio. These metrics, combined with a focus on selecting companies with solid dividend growth rates and manageable debt levels, have made RDVY one of the best dividend-focused ETFs to own since its inception in 2014.

However, I’m taking a more cautious approach on RDVY today and downgrading my rating to a hold. The reason is that it has an above-average volatility level and the potential for a more substantial drawdown like what occurred in Q1 2020. Investors are likely to get a much better entry point shortly. Therefore, I recommend waiting until next month when its Index reconstitutes to see if a better setup emerges.

ETF Overview

Strategy, Sector Exposures, and Top Holdings

The NASDAQ US Rising Dividend Achievers holds companies that have paid more dividends in the last year than in the previous three and five years. Importantly, companies must have a higher EPS than they did three years prior, cash to total debt ratio greater than 50%, and a trailing twelve-month dividend payout ratio less than 65%. These screens ensure that companies are highly profitable, have the flexibility to repay debt with existing cash flows, and don’t overextend themselves on dividend payments. Reconstitutions are annually in March, and the Index is rebalanced quarterly to equal weights.

RDVY has about one-third each dedicated to the Technology and Financials sectors. As shown, it’s a departure from the balanced approach reflected with the SPDR S&P 500 Index ETF (SPY) or the Vanguard Dividend Appreciation ETF (VIG). I chose VIG for its similarly low yield and in recognition that it’s been one of the better dividend-focused ETFs in the last decade.

Please note that Global Industry Classification Standards (GICS) are not used on the First Trust website, resulting in Technology showing just a 24.74% weighting. In particular, Mastercard (MA), Visa (V), Automatic Data Processing (ADP), and Accenture (NYSE:ACN) are classified in the Industrials sector. Different sectors are listed for six additional stocks as well.

The table below highlights RDVY’s top 15 holdings. Since it’s an equal-weight fund, only consider this a small sample. I will be providing industry-level metrics later, covering more than 80% of the ETF.

Historical Performance

Morningstar provides an excellent performance snapshot of the three ETFs below, showing that RDVY has matched SPY’s performance in the last five years and outperformed VIG by 1% per year. It’s also had the edge over the last one- and three-year periods and had a better start to 2022. Through January, it’s outperformed SPY by 2.46%, and through February 23, it’s beaten by 4.04%. Please note that the annualized since inception figures below are misleading; the comparison tool does not appear to align dates for an apples-to-apples comparison properly. RDVY has not outperformed by such a wide margin, as I’ll highlight after.

Portfolio Visualizer’s backtesting tool will let you make fair comparisons, and it shows that RDVY outperformed SPY and VIG by 0.63% and 1.78% per year through February 23, 2022. However, when considering volatility and risk-adjusted returns (Sharpe Ratio), RDVY was the worst option.

The significant 28.28% drawdown in Q1 2020 reflected how poorly the market treated Financial stocks at the time. The SPDR Financial Select Sector ETF (XLF) lost 31.75% that quarter, but it rebounded strongly. Since my buy recommendation in November 2020, it’s outpaced SPY by more than 20%. These are the types of buying opportunities I look for, except I think it’s more likely to happen with Technology stocks next time.

Who RDVY Isn’t For

Before we go any further, I want to give my opinion on who RDVY isn’t for, as it will be challenging to get on board if one or several of these points rings true for you.

1. The fees of 0.50% are incredibly discouraging. I’m a strong proponent of keeping expenses to a minimum as they compound just like reinvested dividends would. RDVY has consistent outperformance net of fees, but it will still have its down years, and paying high fees for an underperforming ETF is frustrating. You need to buy into the strategy but commit to reviewing it periodically as its annual reconstitutions typically result in significant changes.

2. RDVY’s underlying holdings yield less than 2% but have grown their dividends at a rate of 17.35% in the last five years. However, RDVY yields just 1.12% and has a five-year dividend growth rate of 1.13%. The main reasons for these differences are fees and turnover. The 0.50% expense ratio is subtracted from the dividends the fund receives before distributing to shareholders, stunting both yield and growth. High turnover also means the fund can rotate into stocks with different dividend profiles each year. In short, don’t buy RDVY if yield or dividend growth is important to your strategy.

3. RDVY is usually more volatile than the broader market, making it inappropriate for risk-averse investors. Generally speaking, and without consideration for what sectors the fund is exposed to, you can expect it to rise higher than the S&P 500 in bull markets but decline further in bear markets.

4. RDVY only has 50 holdings and is heavily concentrated in just two sectors (Technology and Financials). Unless you have a bullish view of one or both of these sectors, it doesn’t make sense no matter how much you like the strategy. Factor-based ETFs often sound great and use logical screens, but my research consistently shows that sector allocation choices drive excess returns more than stock selection choices within each sector. In other words, investors should put most of their effort into getting their sector allocations right.

If these disadvantages aren’t game-changers for you, I hope you’ll find my fundamental analysis in the next section helpful too. To begin, here is a summary of RDVY’s key metrics as of February 23, 2022.

• Current Price: $48.11
• Assets Under Management: $8.35 billion
• Shares Outstanding: 188.15 million
• Expense Ratio: 0.50%
• Launch Date: January 6, 2014
• Trailing Dividend Yield: 1.12%
• Three-Year Dividend CAGR: 6.55%
• Five-Year Dividend CAGR: 1.13%
• Five-Year Beta: 1.13
• Number of Securities: 50
• Portfolio Turnover: 45% (46%, 40%, 63%, 62% From 2017-2020)
• Assets in Top Ten: 23.78%
• 30-Day Median Bid-Ask Spread: 0.02%
• Tracked Index: NASDAQ US Rising Dividend Achievers

As shown, it’s a well-established fund with $8.35 billion in assets under management and over 188 million shares outstanding. The percent of holdings in the top ten suggests the 50-stock fund reflects the equal-weighting scheme, and the small bid-ask spread indicates high liquidity. All good features, in my view. In particular, when an Index contains so few holdings, it’s crucial for diversification purposes that no single holding has a high weight at any time.

Fundamental Analysis

RDVY is unique because it holds companies growing sales and earnings at above-average rates and still has a low P/E. I’ve seen this occasionally with other ETFs, and they have usually ended up performing well. The downside is the high volatility, and a prolonged market downturn likely won’t favor RDVY. Here is a summary of RDVY’s fundamental metrics for its top 20 industries, which total 83% of the ETF. I have made a comparison against SPY and VIG so you can see the different setups.

The high volatility I already discussed is a significant disadvantage and will likely catch up to RDVY if the market continues downward. However, the ETF has the lowest forward price-earnings ratio by far (15.47x) compared with SPY and VIG. Earnings growth projections are on par with SPY (19.29% vs. 20.21%), and its constituents reported slightly better revenue surprises this earnings season (3.21% vs. 2.66%). My recommendation is to think about how the market will respond next based on three factors: volatility, growth, and valuation. In my view, RDVY has the edge on growth and valuation but not on volatility. Dividend investors looking to add in a growth-at-a-reasonable-price ETF may want to consider RDVY, but others already exposed to high growth stocks should probably avoid it.

Finally, the 5Y Total Return column confirms RDVY’s shift to value over the last year. Recall how RDVY has matched the returns of SPY over the previous five years, but its current constituents’ returns trail SPY’s by nearly 60%. Financial sector stocks, particularly Diversified Banks like Citigroup (C), have been laggards but should begin to outperform once interest rates rise. Even RDVY’s semiconductor holdings, which include Intel (INTC) and Skyworks Solutions (SWKS), are substantially behind SPY’s holdings in that industry, which overweights NVIDIA (NVDA) and Advanced Micro Devices (AMD). These two stocks have averaged a 734% gain in the last five years.

Investment Recommendation

Due to its high concentration and high volatility levels, I am more cautious than usual on RDVY today, so I have decided to downgrade my rating to a hold. I think it’s important to take a diversified and conservative approach at this time and feel it’s prudent to steer readers away from making any big bets on just a couple of sectors. RDVY still looks good from a fundamental perspective, as its 15.47x forward price-earnings ratio and near 20% EPS growth rate is one of the best you’ll come across. However, I’m fearful of another substantial drawdown like in Q1 2020 and believe a better entry price is forthcoming once the dust settles. Thank you for reading, and I look forward to providing another update after RDVY’s Index reconstitutes next month.