DGRO - DGRO Vs. RDVY: Same Goals Different Approaches

2024-01-05 23:51:55 ET

Summary

• DGRO and RDVY cater to income investors looking for dividend growth.
• The differences between the two can be a reason for confusion, so this post will explore and interpret them.
• My view is that DGRO is superior to RDVY, but only slightly. Investors are urged to read this comparative review if they're interested in what these funds have to offer.

Income investing serves many of us. Even though we have varying reasons for our preference toward dividend-paying corporations, we share the same goals most of the time; we want to capture or develop a decent average yield on cost, require the prospect of dividend growth, look for factors that make the distribution safe, and expect that our capital will not only be preserved but appreciate in value.

This is why I wanted to cover two well-established funds that seem to cater to that investor profile. The iShares Core Dividend Growth ETF ( DGRO ) and First Trust Rising Dividend Achievers ETF ( RDVY ) focus on providing exposure to U.S. stocks that have been increasing their dividends over time.

I observed some interest in those instruments and, in this post, I will thoroughly compare them to help you understand which may be best for you. Both have some value to offer, but because of their differences, the selection of either depends upon your own needs and to what degree you appreciate each advantage each has over the other.

Overview & Methodology

As you can see from the table above, what stands out is that DGRO manages a lot more funds than RDVY, it is a lot more diversified, and it weighs positions based on the total dividends a company pays, while RDVY equally weighs the holdings.

I personally prefer ETFs with a large amount of AUM, but I wouldn't put too much weight on it here as both funds are equally large enough for me. Of equally low importance is the level of diversification in my opinion. If a fund owns dozens of stocks, this is adequate for me; hundreds may be safer, but I don't place much weight on that either.

However, I believe it's preferable to invest in a fund that equal-weighs its securities. There's nothing wrong with dividend dollar-weighting, but it's similar to market cap-weighting in that it basically exposes you to the biggest players but defines size based on dividend amounts instead of market capitalization. Consider that the biggest positions of DGRO are also the largest companies based on market cap; it's natural for bigger corporations to share a bigger portion of their earnings. And while market cap weighting may be useful when trying to capture the returns of a specific market as accurately as possible, I don't see how larger distributions across companies of different sizes can offer the investor any significant value apart from simplicity. Yes, simplicity can result in lower transaction costs, but the higher returns equal weighting can bring can more than offset them. Something to keep in mind as we go forward.

Another thing you should know is how diversified each ETF is. But before we move on to that, let me explain the different approaches to security selection each one has.

DGRO tracks the Morningstar US Dividend Growth Index, which has the following criteria for including stocks:

• A company must pay a qualified dividend
• It must have at least 5 years of uninterrupted annual dividend growth
• Its earnings payout ratio must be below 75%.

Here's a caveat you should be aware of though. The top decile of the dividend payers based on dividend yield is not even screened. This could be supported on the basis of the dangers often correlated with high dividend yields. But it's unjustifiable in my view. Sure, plus-10% yielding dividend stocks could be unsafe income instruments, but this isn't always the case. If a company fulfills the above criteria, I don't see why it should be unworthy of inclusion on the basis of a high dividend yield. Just my two cents.

Coming to RDVY, this tracks the NASDAQ US Rising Dividend Achievers Index which has its own set of rules:

• A company must have paid a dividend in the trailing 12-month period greater than the dividend paid in the trailing 12-month period three and five years prior.
• It must have earnings-per-share in the most recent fiscal year greater than earnings-per-share in the three prior fiscal years
• It must have a cash-to-debt ratio greater than 50%
• It must have a trailing 12-month payout ratio that is below or equal to 65%.

That's very interesting. So, it's stricter than DGRO because of the lower payout ratio and the additional profitability and liquidity metrics. At the same time, it is also more relaxed regarding whether the dividend growth has been uninterrupted or not and dividends don't have to be necessarily increased every year; it requires some dividend growth to be present.

I would have to say that RDVY's methodology is more sophisticated. I like the "5 years of uninterrupted annual dividend growth" criterion of DGRO more, but its payout ratio screen is more forgiving and lacks profitability/liquidity screens that can increase the likelihood of a healthy issuer.

Allocations

Moving to the allocation profile of each fund, this is DGRO's sector exposure:

And here's RDVY's:

Not surprisingly, DRVY is way more exposed to Financials. As far as I can tell, companies belonging to that sector are the most likely to pass screens like the ones that ETF's index applies. I wouldn't say, however, that this presents a serious threat as the sector is not very volatile. It's also good to know that the index DRVY tracks won't allow for more than 30% exposure to any single sector. Yes, DGRO is more diversified by definition. But context is important when deciding what weight to place on such "better diversification".

Now, as expected, DGRO's top 10 holdings are given weights according to the size of their dividends, which also correlates to market cap size as I discussed above:

RDVY equal-weights its positions instead:

Even if I personally prefer equal weighting, it does translate into higher transaction costs. So, it's time we discuss this.

Cost

RDVY is more expensive to hold in every single way as you can see. The expense ratio is very high both compared to DGRO's very low one and ETF fees in general. Same with turnover; 59% is obviously the result of the more sophisticated methodology that makes the composition of the index more sensitive to change. Daily volume is a lot lower too, but still high enough to not be important here.

Performance

As for their performance, both have succeeded in establishing a record of capital appreciation, with significant additional returns coming from distributions. Not surprisingly, RDVY has outperformed DGRO based on both price isolated and total return. And that's the reason cost should always be viewed within the context of the value offered. Equal weighting and a more sophisticated methodology don't necessarily have to yield better results, but this seems to be the case here.

However, the difference is not huge considering the almost 10 years of performance depicted above. DGRO has been compounding at an average of 11.01% per year, while RDVY realized a compound average return of 12.04%. Based on the performance history, DGRO has also realized a Sharpe ratio of 0.7 and RDVY a lower one at 0.63. Therefore, DGRO is clearly the winner when it comes to risk-adjusted returns.

Now, both funds are highly correlated to the market, but RDVY's returns have managed to keep it a little bit ahead:

Definitely something valuable if you're looking to generate income but are in no hurry to underperform the market as you do so. Speaking of income, the TTM yield of DGRO is 2.47%, while RDVY's TTM yield is 2.31%; close enough to make them both seem equally unattractive to income investors.

Regardless, these are dividend growth funds. They're not supposed to identify high-yielding dividend stocks, but companies that are most likely to keep increasing their dividends. This is still valuable to patient investors who want to eventually realize a high yield on cost.

So, it's more relevant to compare the distribution records of the ETFs. Here is DGRO's:

And here is RDVY's:

Both have about doubled their distributions since they were launched, but RDVY has arrived at its current one by growing it more erratically.

Risks

Before I conclude, I want to mention a few risks that come with investing in these funds.

First, DGRO currently has a P/E ratio of 18.63 and a P/B of 3.39. Even though these are subject to change, an investment in the ETF right now implies buying at relatively high multiples which can be risky. To put these multiples in context, RDVY has a P/E of 11.51 and a P/B of 2.10. Buying at a premium when it comes to such big underlying corporations is inevitable, but selecting the fund that has outperformed in the past and has low multiples could mitigate the risk that comes with buying at such a premium.

Now, RDVY has a lot of exposure to Financials at this time. I personally don't view this as a negative, but if a certain crisis hits the sector, it could result in significantly higher volatility for the fund; something that may translate into losses if investors lose their confidence and this is likely with many who are not properly prepared for the risks.

Speaking of volatility, RDVY has realized an annual standard deviation of 18.96% all these years and its maximum drawdown has been 28.28%. So, it is very likely you are going to experience more severe ups and downs than simply holding a broad-market index fund. Again, this can only lead to loss if it shakes your confidence. Greater diversification may help you avoid that. That reminds me that RDVY is exceptionally less diversified than DGRO and other dividend funds out there. So, it also carries a concentration risk.

Last, RDVY has reached its current annual payout with a couple of decreases over time. For this reason, it's more difficult to trust that the distribution will increase fast enough to benefit investors. Thus, an opportunity risk is also present here.

Verdict

All in all, both ETFs have their own strengths and weaknesses and some things fall under the category of subjective. Though I appreciate the approach of RDVY, it's much more expensive than DGRO and I don't trust that it's going to provide the same value as its competitor in the long run because of the distribution record.

However, as I said above, it comes down to what your needs are. My verdict is less useful than outlining the data and offering my thoughts on each difference I identify as I did above. So, it's very likely you have reached a different conclusion than mine after reading this post.

Whatever it is, I'd like to know. Make sure you leave a comment below and let me know if you own either ETF and why/why not. Thank you for reading!

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