IYW - TDIV: Why I Would Avoid This ETF

2023-11-07 08:38:00 ET

Summary

• First Trust NASDAQ Technology Dividend Index Fund tracks the Nasdaq Technology Dividend Index and focuses on higher-yielding technology and telecom companies.
• TDIV has significantly underperformed historically due to security selection.
• TDIV's selection criteria result in it running underweights to key technology companies such as Apple, Alphabet, Meta, and Nvidia.
• Investors should consider market cap weighted indexes instead of TDIV to ensure they are getting exposure to the best companies and avoid being overweight slow growth tech companies.

ETF Overview & Index Description

The First Trust NASDAQ Technology Dividend Index Fund ( TDIV ) seeks to track the performance of the Nasdaq Technology Dividend Index.

In order to be included in the Index, the security must meet the following criteria:

• Listed on the Nasdaq, NYSE, or NYSE Amex
• Classified as a technology or telecommunications company according to Industry Classification Benchmark
• Have a minimum market cap of $500 million
• Have a minimum three-month average daily dollar trading volume of $1 million
• Have paid a regular or common dividend within the past 12 months
• Have a yield of at least 0.50%
• Have not had a decrease in common dividends per share paid within the past 12 months
• Not be issued by an issuer currently in a bankruptcy proceeding

The Index employs a modified dividend value weighting methodology. At each evaluation, Index holdings are classified as technology or telecommunications. Technology securities are given a collective weight of 80% and telecommunications securities are given a collective weight of 20%.

The Index is rebalanced quarterly.

TDIV currently holds 84 securities, has ~$2 billion in total net assets, and has an expense ratio of 0.50%. Fund characteristics include a trailing P/E multiple of ~17x and a 12-Month Distribution Rate of 1.93%.

High Management Fee

TDIV has a relatively high expense ratio of 0.50%. To put that into context, the average expense ratio for an actively managed equity mutual fund is ~0.66% and the average equity ETF expense ratio is ~0.16%. Comparably, the Invesco QQQ ETF ( QQQ ), which tracks the Nasdaq- 100 has an expense ratio of just 0.20% and the Invesco Nasdaq 100 ETF ( QQQM ) has an expense ratio of just 0.15%.

Weak Historical Relative Performance

TDIV launched in August 2012 and has underperformed that Nasdaq-100 and S&P 500 since then. Since inception, TDIV has returned ~278.5% compared to a return of ~510% delivered by the Invesco QQQ Trust ((QQQ)) which tracks the Nasdaq-100. The SPDR S&P 500 ETF ( SPY ) has returned 281% over the same time period.

While TDIV has delivered a similar total return to the S&P 500, it has done so with higher volatility. Since inception, TDIV has realized an average 30 day rolling volatility of 16.69% compared to 14.45% for the SPY during the same time period.

Given the fact that TDIV maintains a structural exposure of 80% to technology and 20% to telecommunications it also makes sense to consider TDIV's historical performance relative to pure play technology and telecommunications ETFs. Since TDIV's inception, the iShares U.S. Technology ETF ( IYW ) has delivered a total return of 542.7% while the iShares U.S. Telecommunications ETF ( IYZ ) has delivered a total return of 18.9%.

An investment of 80% in IYW and 20% IYZ would have returned 437.9% since inception compared to the 278.5% return delivered by TDIV. This difference suggests that security selection and not just sector exposure has been a major performance headwind.

Holdings Analysis

As shown by the chart below TDIV is somewhat concentrated with the top 5 holdings accounting for ~39.6% of the fund.

Given the 80% structural exposure to the technology sector, we can get a sense of TDIV's differences by comparing top holdings to top holdings in the iShares U.S. Technology ETF ((IYW)).

While Microsoft ( MSFT ) is TDIV's largest holding, the fund is significantly underweight as MSFT makes up 17.92% of IYW. Using an 80% exposure to technology would mean that a market weight exposure in MSFT would be 14.3%. Comparably, TDIV has an 8.9% weighting.

The second largest holding in IYW is Apple ( AAPL ) which accounts for 17.9% of the fund. Using an 80% exposure to technology would mean that a market weight exposure in AAPL would be 14.3%. Comparably, TDIV does not have any exposure to AAPL currently as the dividend had dropped below 0.50% at the time of the last TDIV rebalance.

In addition to running large underweights to MSFT and AAPL, TDIV is also significantly underweight the next three largest IYW holdings Alphabet ( GOOG ), Nvidia ( NVDA ), and Meta Platforms ( META ).

These underweights are offset by overweights to more mature technology, slower growing, higher yielding companies such as IBM ( IBM ), Broadcom ( AVGO ), Texas Instruments ( TXN ), Oracle ( ORCL ), and Qualcomm ( QCOM ).

The telecommunication side of TDIV is a less significant driver of performance as it accounts for just 20% of the total fund. Moreover, TDIV exposures are more in line with the large weights in the iShares U.S. Telecommunications ETF ((IYZ)) as the large telecom companies tend to pay strong and stable dividends.

The three largest holdings in IYZ are Cisco Systems ( CSCO ), Comcast (CMCSA), and Verizon ( VZ ) which account for 17.7%, 14.7%, and 12.9% respectively of IYZ. Applying a 20% weight to these gets us 3.5%, 2.94%, and 2.58% market weight exposures to CSCO, CMSA, and VZ. Comparably, TDIV current has weights of 1.9%, 1.9%, and 2.14% to CSCO, CMCSA, and VZ, respectively. Given these relatively small weighting differences vs IYZ adjusted for 20% exposure, investors should be focused more on the technology part of the portfolio as a driver of performance.

Dividend Investing In Technology Stocks Has Not Worked

Clearly, based on historical performance dividend investing in technology stocks has not proved a successful strategy.

The primarily driver of TDIV's underperformance has been significant underweights to tech stocks that do not pay dividends in favor of more mature technology companies that do pay dividends such as IBM.

I disagree with the strategy TDIV uses as I believe the best technology companies will have growth opportunities to deploy cash into rather than paying a dividend. Moreover, TDIV avoids exposure to companies that choose to focus on buybacks over dividends such as GOOG and META.

Conclusion

TDIV charges a fairly high fee compared to other equity ETFs. The fund's dividend focus has resulted in significant underperformance compared to the traditional capitalization-weighted Nasdaq-100.

Furthermore, while TDIV runs ~80% exposure to technology and 20% exposure to telecoms it has significantly underperformed an 80% technology and 20% strategy using a traditional market cap weighted approach. This suggests that the major driver of TDIV's underperformance has been security selection.

TDIV's approach has resulted in a fund that is underweight the largest technology stocks such as MSFT, AAPL, GOOG, META, and NVDA. On the other hand TDIV is overweight more mature slower growing tech companies such as IBM.

I believe this underperformance is likely to continue going forward given the fact that TDIV is significantly underweight high-quality companies such as AAPL, MSFT, GOOG, META, and NVDA. As such, I prefer capitalization-weighted Nasdaq-100 Index products such as QQQ compared TDIV. For investors looking to overweight tech, I would prefer to own market cap weighted indexes such as IYW.

For further details see: