Talking Point

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Chess not checkers

Investors increasingly chase dividend-paying investments

By Imran Ahmed*

he aphorism Slow and steady wins the race is as applicable to investing in the stock market as to countless other activities. The relentless drip, drip, drip of an annual cash dividend payment helps equity investors go some distance towards the goal of maximising a portfolios total return (total return accounts for both income and capital appreciation from the securities held within a portfolio). Often, a dividend biased equity portfolio also has the additional benefit of providing a safety cushion by reducing the adverse impact of falling stock prices. Dividends typically form an important part of the total return of a stock or index, particularly in the case of value stocks. In returns associated with the US Standard and Poors 500 Index (S&P 500), dividends added over 2% to an investors return (see Table 1). Although the exact contribution depends on the time period analysed. Simply speaking, on a five-year horizon the 2.3% return obtained from dividends comprises almost half of the S&P 500s total return during the period. Moreover, if one includes the compounding effect obtained through a dividend reinvestment strategy, the impact of dividends on the total return of investing in the S&P 500 is enormous (see Table 2). Even if one introduces active, disciplined portfolio management techniques, total returns for a portfolio remain attractive. The S&P 500 Dividend Aristocrats Index provides a good example. S&P Aristocrats Index constituents are members of the larger S&P 500 Index which have also been paying

Table 2: Standard and Poors 500 Index Data

1 Year
S & P 500 (Dividend Reinvested Total Return) S & P 500 (Price Returns) Difference attributable to dividends (1-2) 10.9% 7.4% 3.5%

3 Year
35.5% 23.1% 12.4%

5 Year
69.0% 43.8% 25.2%

10 Year
200.3% 114.6% 85.7%

Average returns calculated from monthly 1, 3, 5, 10 year returns from 12/31/1961 12/31/2012 Source: Dividend Investing and a Look Inside the S & P Dow Jones Dividend Indices, Aye M. Soe, CFA. Standarad and Poors website; accessed on May 6, 2013.

increasing dividends year after year for at least 25 years. These companies are equally weighted in the index. Presently, there are just over 50 members of the S&P Aristocrats Index.1 The S&P 500 Aristocrats Index easily outperformed its plain vanilla S&P 500 Index counterpart over both short- and long-term historical time horizons. On a five and one year basis, the outperformance is over 6%. However, the excess return drops to approximately 4% on a three-year horizon (see Table 3).2 Not surprisingly, the dividend investment theme has been noticed by exchange traded fund (ETF)3 companies and investors alike. In fact, dividend focused ETF investors are spoilt for choice. Theme based ETFs such as the small US$25 million WisdomTree Global Natural Resources ETF (GNAT) tracks an index which is comprised of global dividend paying companies in natural resource industries compete with more general dividend strategy ETFs such as the $600 million First Trust

Table 1: Standard and Poors 500 Index Data (annualised)

1 Year
S & P 500 (Total Return) S & P 500 (Price Returns) Difference attributable to dividends (1-2)
As of April 30, 2013 Source: Standard and Poors website. Accessed on May 6, 2013

3 Year
12.8% 10.4% 2.4%

5 Year
5.2% 2.9% 2.3%

16.9% 14.3% 2.6%

Value Line Dividend Index ETF (FVD). FVD is designed to track an index which is a modified equal dollar weighted index comprised of US exchange listed securities of companies that pay above-average dividends and have the potential for capital appreciation. Investors looking for an international flavoured dividend ETF are not neglected. The PowerShares International Dividend Achievers ETF (PID), with over $800 million in assets, offers one option.4 The PID invests in non-US incorporated companies, which meet certain liquidity requirements and have increased dividend payouts every year for the last ten years.5 Arguably, ETFs are an ideal vehicle for investors searching for yield. Active portfolio management is tempered with a discipline inculcated through an index replication methodology, i.e. ETF portfolio managers must operate within the framework of a benchmark index through which risk is constrained. Additionally, the typically lower total expense ratios and transparency requirements of an ETF versus say a mutual fund or managed account make the ETF vehicle superior to most other competitors. Investors seem to agree. Year-to-date money flow into the dividend income ETF category stands at $10.9 billion. If one aggregates inflows into real estate and preferred stock-oriented ETFs, then the more broadly classified yield oriented ETF sector has raised almost $20 billion during the first four months

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Talking Point
constituents and even the temptation to modify index methodology to boost performance during periods or poor returns are some of the fears expressed by critics of self-indexing. Dividend-focused ETFs are a bright spot within the equity ETF space. It is likely the sectors growth will continue for both fundamental and cyclical reasons. Fundamentally, there is a large body of academic evidence which suggests that investing in stocks with above average dividend characteristics provides returns superior to simply investing in a broad market index. Cyclically, the world seems to be braced for a period of continued low interest rates, thus making cash dividends an extremely valuable commodity for yield seeking investors. Undoubtedly, ETF company marketing machines will ensure the equity dividend ETF sector remains prominent in the industrys efforts to attract fresh money into the international ETF business.
*Imran Ahmed is a principal at Deodar Advisors LLP.

Table 3: Standard and Poors 500 versus S & P 500 Dividend Aristocrats (annualised)
1 Year
S & P 500 Dividend Aristocrats Index S & P 500 Difference attributable to active management (1-2)
As of April 30, 2013 Source: Standard and Poors website. Accessed on May 6, 2013

3 Year
16.7% 12.8% 3.9%

5 Year
11.8% 5.2% 6.6%

23.3% 16.9% 6.4%

of 2013. In April 2103 alone, dividend income equity ETFs witnessed an inflow of $3.4 billion more than 30% of Aprils net inflow of $9.6 billion into equity ETFs.6 One can expect the recent trend of positive money flows into dividend yield focused ETFs to continue gathering pace in the coming months. Presently, most of the ETFs in the dividend area replicate external indices to achieve investment objectives. WisdomTrees Total Dividend (DTD) and Dividends (ex-financials) (DTN) ETFs are

prominent exceptions and use in-house indices. However, in line with broader ETF industry trends, the dividend ETF sector will have to address the issue of self-indexed versus externally indexed funds. Certainly, self-indexing or using an in-house benchmark for an ETF might save investors a little money. However, especially for rule-based ETFs like DTD and DTN, which border on the verge of actively managed funds, self-indexing raises conflicts of interest concerns amongst investors. Valuation, pricing of

He can be reached at Imran@deodaradvisors.com

Table 4: A Sampling of Dividend / Yield Focused ETFs

Symbol
Vanguard Dividend Appreciation ETF iShares Dow Jones Select Dividend Index S and P Dividend ETF Vanguard High Dividend Yield Index ETF Shares High Dividend Equity ETF Wisdom Tree Dividend (ex-financials) ETF First Trust Value Line Dividend Index ETF First Trust Morningstar Dividend Leaders Index ETF WisdomTree Total Dividend ETF PowerShares Dividend Achievers ETF
Performance and AUM data as at March 30, 2013 Source: Yahoo! Finance accessed on May 8, 2013

AUMs (US$ millions)

17,600 11,800 11,040 7,480 2,840 1,090 606 590 297 289

Yield
2.2% 3.4% 2.8% 3.0% 3.2% 3.9% 2.6% 3.6% 2.8% 2.1%

Year to date Return

10.8% 11.8% 14.1% 11.7% 12.2% 12.4% 12.5% 12.8% 10.9% 11.7%

1 Year Return
14.9% 17.6% 20.2% 16.8% 18.4% 18.1% 17.9% 20.9% 15.1% 16.4%

3 Year Return
12.9% 15.4% 13.9% 14.9% n/a 17.5% 14.5% 17.0% 14.8% 14.0%

VIG DVY SDY VYM HDV DTN FVD FDL DTD PFM

 ource: S & P 500 Dividend Aristocrats Methodology Fact Sheet, Standard and Poors website; accessed on May 6, 2013. S http://www.standardandpoors.com/indices/sp-500-dividend-aristocrats/en/us/?indexId=spusa-500dusdff--p-us--- ource: see 1 above and S & P 500 Index information, Standard and Poors website; accessed on May 6, 2013. S http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l-For the purposes of this article, the generic term ETF refers to exchange traded portfolios comprised of various structures, including exchange traded notes (ETNs). All data on specific ETFs, including index characteristics, obtained from Yahoo! Finance; accessed on May 8, 2013.  ividend Achievers introduction, Indxis website; accessed on May 6, 2013. D http://www.indxis.com/DividendAchievers.html  lackRock, ETP Landscape, Industry Highlights. April 30, 2013; accessed May 8, 2013. B http://www.blackrockinternational.com/content/groups/internationalsite/documents/literature/etfl_industryhilight_apr13.pdf

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