FDVV - FDVV: Fidelity Smart Beta ETF's Smart Sales Pitch Is One Investors Should Be Skeptical Of

2023-12-23 00:13:02 ET

Summary

• Fidelity High Dividend ETF is part of Fidelity's smart beta approach to portfolio construction, targeting specific security characteristics.
• The ETF combines active and passive management to try to mitigate risk, enhance returns, and help express an investment view.
• But my concern is that this is a pseudo-growth ETF that investors will mistake for dividend focused fund. It can potentially create confusion.

I'm skeptical of many offerings from the behemoth mutual fund companies that finally realized that mutual fund assets are receding, and the money is largely converting to ETFs. I'm a self-admitted ETF geek, 30 years into my journey into this innovative security type. And while I'm glad to see the big mutual fund providers join the fray, I don't see too many attractive alternatives to some of my favorite established ETFs. This is particularly the case when it comes to dividend ETFs. So, while I gave a fair look to Fidelity High Dividend ETF ( FDVV ), I'm not a fan. Here's why.

FDVV is a targeted factor ETF that is an integral piece of its smart beta approach to portfolio construction. Fidelity has a number of factor ETFs that it believes point to certain security characteristics with a variety of purposes: strategic focus, representing buy and hold strategies which allow investors to participate in market returns, and tactical factors which express a market view based on the where the market is in the business cycle and expected anticipation of the next move in the cycle. Finally, the focus is on portfolio construction, and the firm likens factor ETFs as tools to target precise exposure to supplement a portfolio similar to a multivitamin filling a gap in one's nutritional needs.

This is all fine marketing, as one would expect from one of the most successful investment firms of all time. But Fidelity's version of smart beta, while it might be innovative in growth stock areas, is disingenuous when it comes to dividend stock investing. For example, here are this 110-stock portfolio's biggest performance contributors in 2023:

An ETF by any other name...

Those are stocks that pay dividends but they are barely dividend stocks at this stage of the market cycle. I'm not at all arguing that holdings like this have hurt the fund. They have, in fact, driven its strong past returns. It is the future I'm concerned about. And more importantly, the potential for investors to own FDVV and think they have something they don't. This ETF has a 40% drawdown on its record, and its exposure to Mag-7 names will look awful at some point, when the fingers are pointed at that exposure for taking down a "dividend ETF."

More specifically, 3 of the Magnificent 7 (MSFT, AAPL, NVDA) are FDVV's 3 largest holdings, accounting for 16.5% of the ETF. 24% of the fund is allocated to the technology sector. That sounds like a pretty big sector bet and smells like FDVV is attempting to provide a back door into momentum stocks, under the guise of a dividend ETF. When you are a giant fund company that is largely confined to a fraction of the overall stock market population, this is understandable. But also very unattractive.

Now, FDVV does yield 3.8%, which not long ago was a hefty yield. But the dividend space has suffered some steep losses the past 2 years, and many peers now yield 4.5% or more.

FDVV is a mix of active and passive management, hence the smart beta label. The ETF is comprised of 100 long holdings and 3 short. By combining quantitative and fundamental analysis, Fidelity believes it can mitigate risk, enhance returns, and express an investment view. Its primary underlying index is the Fidelity High Dividend Index.

The Fidelity High Dividend Index is comprised of large- and mid-cap dividend paying companies which are likely to continue paying dividends and continue to grow them. Fidelity constructs this index by sifting through the Russell 1000 companies and picking the top quintile companies by dividend yield annualized returns.

Its secondary benchmark is the Russell 1000. The Russell 1000 is a broad market index representing the largest 1000 in the US by market cap, thus even broader than the S&P 500 Index, often the benchmark for the market. Fidelity believes by mimicking these indices, it mitigates risk by controlling for market cap, sector concentration and by having a low concentration in any one stock.

While this investment thesis may work in concert with its other factor ETFs, I don't see the value in FDVV. Much of my concern centers around its holdings.

The chart above tells a simple message. When I compare FDVV to an ETF that owns the 80 highest S&P 500 yielders, FDVV has trounced that index. But its historical performance versus that index is extremely cyclical. That's because FDVV is a high yield ETF in disguise. So when its mega cap growth names surge, it looks like the top of the line in "dividend" ETFs.

Final thoughts

But to me, FDVV is less a dividend ETF than it is one with a confusing mandate. It is currently riding its highest level of outperformance versus a true dividend ETF in a few years. That in itself is, sort of like a sentiment indicator, a situation where tops should be considered relatively unattractive. It gets a Sell rating from me.

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