SPYD - LVHD: Low Volatility High Dividend And Built For A Changing Market

2024-01-09 03:04:17 ET

Summary

• LVHD is an income-focused ETF that combines large- and mega-cap value stocks with small- and mid-cap blended growth stocks.
• The ETF primarily invests in companies with market caps over $50 billion, with a focus on dividend-paying companies that have strong earnings and experienced management teams.
• LVHD has a sector allocation that includes utilities, consumer staples, industrials, REITs, and financials, and it has a lower concentration in technology stocks.

Every income investor dreams of reliable income with low volatility. Throw in a nice valuation discount and macroeconomic factors supporting capital appreciation and you've struck gold. Well, the golden version of dividend income, anyway.

Through its proprietary selection process, Franklin U.S. Low Volatility High Dividend Index ETF (LVHD) seeks to tick the box of large and mega-cap value with a splash of small and mid-cap blended growth. The top 34% of holdings are in companies with market caps over $50 billion, 48% are companies with market caps between $10 and $50 billion, with small and mid-cap stocks rounding out the bottom 20%.

Companies that pay dividends, especially higher dividends, tend to be established lower-growth companies with strong earnings and seasoned management teams. These companies are less likely to cut or suspend dividends and are skilled at growing earnings.

LVHD fishes in a pool of 3000 large-, mid-, and small-cap U.S. equities as determined by the Solactive US Broad Market Index. Although passively managed, the Franklin portfolio team combs through their stock universe and selects profitable companies capable of supporting relatively high dividend yields coupled with screened companies that have lower price and earnings volatility, ultimately selecting roughly 125 securities. LVHD is reconstituted annually and rebalanced quarterly, in line with average ETF practices.

Sector Allocation and Stock Concentration

LVHD rounds up the usual dividend-paying suspects, which combined comprise 80% of the portfolio: Utilities (21%), Consumer Staples (20%), Industrials (13%), REITs (13%), and Financials (13%). It has enough equities to go beyond that of a "highly-concentrated" ETF, but with 126 equities, we consider LVHD a subsector of SPY. Thirty-six percent of LVHD's holdings or 44 companies are SPY, although LVHD takes a much stronger bet on Utilities, REITs, and Consumer Staples.

With investment rules in place that individual stocks have concentration limits of no more than 2.5% of the portfolio and individual sectors no more than 25% (15% for REITs), individual equity risk is minimized. However, this ETF takes a stronger bet on sector allocation.

As the chart below shows, that has caused LVHD to lag behind some of the more popular and established divided ETFs like iShares Select Dividend ETF ( DVY ) and SPDR Portfolio S&P High Dividend ETF ( SPYD ). The go-go market of 2021, following the initial pandemic relief rally in 2020, left LVHD behind. But beyond that, these 3 rivals have been largely in sync, except that LVHD has outperformed modestly in sharp broad market declines. This is as much a past performance issue for dividend and value stocks in recent years as anything.

Macro Factors Looking Up for LVHD in 2024

We believe the old adage "You can't fight the Fed" is as relevant today as ever. Combine that with our belief that you can't fight fiscal policy either, the utility portion of LVHD is set to soar as the 2022 Inflation Reduction Act (IRA) ramps up. Couple potential rate stabilization and rate cuts with the 2022 IRA tax incentives heating up and there are some macro issues that potentially favor this ETF.

What does that mean? The 2022 IRA intends to help accelerate the transition to green energy, build out and update the national electric grid, and help liquid natural gas building out and expansion. Utilities, mid-stream operators, and infrastructure companies are set to benefit tremendously from the IRA.

LVHD could potentially break ahead of DVY and SPYD as it has higher concentrations of utilities and infrastructure companies.

Valuation

A couple of data points about this LVHD should be front of mind for any investor considering it. Its current portfolio sells at 16x trailing earnings, a discount to the broad market. And, it allocates only 3% to technology stocks. So if 2024 is a year in which performance reverts to the mean, with tech underperforming value, this is a short-list buy candidate.

We believe LVHD provides a solid long-term position in an income portfolio looking for lower volatility. That discounted valuation is not bad. However, from a valuation perspective, we believe LVHD's forward P/E to be trading at a 9% discount to its trailing P/E compared to its benchmark trading at an 8% discount. We would like to see a greater divergence in valuation before we would put a buy rating on this ETF.

And, as pictured above, LVHD's standard deviation has been consistently below the other 2 ETFs we've compared it to. Its dividend yield is a respectable 3.5% although it trails DVY's 3.8% and SPYD's 4.7%.

Is LVHD the best of the very large dividend ETF peer group? No. But it is competitive amongst its peers, particularly looking forward.

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