FDL - FDL: By Investing In Core Sectors It Generates Steady Yields And Impressive Returns

2023-10-01 04:24:33 ET

Summary

• First Trust Morningstar Dividend Leaders Index Fund (FDL) is an ETF that invests in dividend-paying stocks of large-cap companies.
• FDL focuses on core sectors like financial, energy, and utilities, with a portfolio of 100 securities.
• FDL has generated a steady and decent yield, with impressive total returns, but major investments in banking stocks have posted consistent price loss.

~ by Snehasish Chaudhuri, MBA (Finance)

First Trust Morningstar Dividend Leaders Index Fund ( FDL ) is an exchange traded fund that invests in dividend paying stocks of large-cap companies operating across diversified sectors. The fund holds roughly 100 securities and does not invest in REITs. It tracks a dividend-weighted index of US entities which have a track record of consistent and sustained dividend payments. As a result of this, the fund has been able to generate steady and decent yield on a consistent basis. Total returns over the long run also have been impressive. FDL's price multiples are also much lower than that of its benchmark index, as well as its peer funds. FDL seems to be a good option for long-term investors.

FDL Mostly Invests in Stocks from Core Sectors Like Financial, Energy and Utilities

First Trust Morningstar Dividend Leaders Index Fund benchmarks itself against the performance of Morningstar Dividend Leaders Index and uses full replication techniques in order to create its portfolio. This index tracks the performance of 100 highest-yielding stocks that have a consistent record of dividend payment and envisages an ability to sustain those pay-outs. Almost half of its entire portfolio is invested in two core sectors of the economy - energy & utilities and financial. FDL has an AUM of $4.07 billion, and a high expense ratio of 0.45 percent. High expense ratio resulted from an equally high turnover ratio of 60 percent . FDL is currently trading at par with its NAV.

FDL's total returns have been impressive. Annual average total return between 2016 and 2021 was close to 12 percent. Even during the last year, when most funds posted massive price loss, FDL posted a price growth of 6.65 percent.

FDL Constructs its Portfolio by Putting Special Emphasis on Yield Generation

First Trust Morningstar Dividend Leaders Index Fund was formed on March 9, 2006 by First Trust Advisors LP. Since then, the fund has been paying quarterly dividends with decent yield . Trailing-twelve-month yield stands at 4.68 percent. Since 2020, annual average yield has been in excess of 4 percent. The yield is also quite consistent and ranged around 4 percent only. In order to generate a greater dividend yield, FDL tries to build its portfolio on the basis of historical yield performance and the ability to sustain their dividend payments.

FDL invests only in those companies, whose current dividend is higher than it was five years ago, and also less than its forward EPS estimates. This largely ensures the sustainability of future pay-outs. Eligible securities are then ranked by their respective yields, and the top 100 securities are selected in the index. Morningstar Dividend Leaders Index is also dividend dollar-weighted. The Index undergoes quarterly rebalance and annual reconstitution. In order to avoid concentration risk, investment in a particular stock is restricted up to a maximum of 10 percent of the total assets, and it is ensured that securities weighing more than 5 percent of the entire portfolio, do not collectively exceed half of the portfolio. Such an approach results in a deviation from the index.

FDL's Major Investments in Banking Stocks Posted Price Loss on a Consistent Basis

The list of top investments of First Trust Morningstar Dividend Leaders Index Fund is dominated by diversified and regional banks such as Citigroup Inc. ( C ), PNC Financial Services Group, Inc. ( PNC ), Truist Financial Corporation ( TFC ), U.S. Bancorp ( USB ), M&T Bank Corporation ( MTB ), Regions Financial Corporation ( RF ), Fifth Third Bancorp ( FITB ), Huntington Bancshares Incorporated ( HBAN ), Citizens Financial Group, Inc. ( CFG ) and KeyCorp ( KEY ). Unfortunately, all these stocks generated negative price growth in the range of -10 percent to -40 percent. FDL's price also dropped by 8.28 percent. Not only that, price growth over the past 5 years has also been negative for all these stocks. FDL, however, successfully generated a price CAGR of 2.28 percent.

Energy Stocks Had Been Quite Stable While Utility Stocks Had a Mixed Performance

Energy & utilities sector can be divided broadly in two segments. First group of companies are engaged in oil and gas exploration and production. Major investments from this sector include Chevron Corporation ( CVX ), Duke Energy Corporation ( DUK ), Pioneer Natural Resources Company ( PXD ), LyondellBasell Industries N.V. ( LYB ), Phillips 66 ( PSX ) and Devon Energy Corporation ( DVN ). Energy stocks are mostly stable stocks, and thus over the long-run these stocks generate steady returns. Despite covid-19 pandemic, Russia's invasion of Ukraine, high inflation, and multiple interest rate hikes, these stocks mostly registered price growth in between 10 to 40 percent during the past 5 years.

Another group of energy & utilities stocks belongs to gas and electricity suppliers such as Southern Company ( SO ), Edison International ( EIX ), Entergy Corporation ( ETR ), FirstEnergy Corp. ( FE ), ONEOK, Inc. ( OKE ), The Williams Companies, Inc. ( WMB ), etc. This group of stocks were not as stable as the energy explorers. Most of them posted negative returns in 2023 and half of them failed to generate positive price growth over the past 5 years. However, over the past 10 years, these stocks generated decent to strong price growth.

Investment Thesis

As First Trust Morningstar Dividend Leaders Index Fund tracks a dividend weighted index of US entities which have a track record of consistent and sustained dividend payments, FDL has been able to generate steady and decent yield on a consistent basis. Due to having 100 highest-yielding stocks in its portfolio, the fund is in a position to sustain its future pay-outs. Half of FDL's entire portfolio is invested in two core sectors of the economy - energy & utilities and financial. FDL's major investments in the banking stocks (both regional and diversified banks) posted price loss on a consistent basis. On the other hand, energy stocks remained mostly stable and generated steady returns over the long-run. Stocks from gas and electricity suppliers had a mixed performance. Overall, FDL's major investments had minimal growth, but nothing exceptional. That's why I won't assign a buy decision to this fund.

As the economy moves beyond high inflation, supply-chain crisis and interest rate hikes, these stocks from the core sector are expected to perform better in the coming years. Even despite poor economic growth, total returns over the long run have always been impressive. Moreover, FDL's pay-out is steady and sustainable. It invests only in those companies, whose current dividend is higher than it was five years ago, and also less than its forward EPS estimates. Its price multiples are also much lower than that of its benchmark index, as well as its peer funds. Thus, First Trust Morningstar Dividend Leaders Index Fund seems to be a very good option for long-term growth investors. Considering all these factors, a hold rating seems justified for the time being.

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