SSGA highlights benefit of dividend ETF for downside protection

Mar 24th, 2016 | By | Category: Equities

US companies with a long track record of consistently raising their dividends (dividend growers) have been found to provide a superior degree of downside protection when compared to broad market exposure, according to research from State Street Global Advisors (SSGA). 

Dividend Growers ETF offers downside protection in volatile markets, says SSGA

Constituents of the SPDR S&P Dividend ETF generally exhibit robust financial strength and strong brand names including: McDonald’s, Walmart, Procter & Gamble, and Chevron.

The report looks at the historical performance of the SPDR S&P Dividend ETF (SDY), a portfolio of stocks from the S&P Composite 1500 Index that have boosted their dividends for a minimum of 20 straight years, compared to the performance of the S&P 500 Index.

It found that the fund suffered smaller drawdowns compared to the S&P 500 during market downturns. For example, during bear markets from 2005 the fund’s tracking index – the S&P High Yield Dividend Aristocrats Index – experienced an average drawdown of 2.9% compared to 3.7% for the S&P 500. During the financial crisis in 2008, the fund lost 23% of its value compared to 37% for the S&P 500.  More recently, the fund has performed better than the S&P 500 during the market volatility experienced in January and February, returning 1.1% between the start of the year and 1 March. In contrast the S&P 500 shed 5.1% in value over the same period.

The theory supporting better performance of dividend growers compared to the average company in market downturns is that the ability to reliably boost dividends consistently over a period of decades suggests the firm has a greater degree of financial strength and discipline. These companies also tend to have strong brand reputations and reasonable business models. They may not offer the highest dividend yields available in the market but the reliability of their cash flows helps them perform better over the long-run on a risk-adjusted basis. Although the hurdle rate for inclusion is 20 years consecutive dividend increases, the index average is actually 35 years, and eight constituents have acquired over 53 consecutive years of dividend increases – some of these companies were increasing their dividends when JFK was President!

Elaborating on this theme, the report states that “companies that have consistently raised dividends for many years tend to have strong balance sheets and businesses. Conversely, high dividend payers with more financial leverage and lower earnings growth may be more likely to cut their dividends. A recent trend to dividend cuts has already begun. These dividend cuts lower the income potential of a high dividend payer strategy.”

The report points to the fact that the constituents of the SPDR S&P Dividend ETF have an average debt-to-equity ratio of 187% versus 256% for the holdings of the iShares High Dividend ETF (HDV). SSGA’s argument is that although broad dividend strategies have performed well recently due to rising equity markets, the extra leverage compared to its dividend growers fund poses a significant risk that dividends may be trimmed during the next downturn. As dividends have historically contributed about one-third of the total return of the S&P 500 since 1926 (with that proportion rising above 50% during certain phases of the market cycle), SSGA proposes that an investment in a more moderate but reliable dividend strategy will yield greater performance over the long run.

As of 22 March 2016, the fund has significant exposure to the financials (22.6%), industrials (16.6%), utilities (14.3%), consumer staples (12.1%) and materials (10.8%) sectors. A total expense ratio of 0.35% applies.

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