VIG - VIG: A Cheap And High Quality Dividend Growth ETF

2023-04-23 12:38:21 ET

Summary

• VIG is the cheapest dividend growth ETF.
• VIG deliberately excludes the 25% highest yielding stocks from its universe of dividend growing stocks and hence has a slightly lower dividend yield compared to other dividend growth ETFs.
• Despite its low beta VIG is outperforming the rising stock market.
• VIG joins SDY as our favourite dividend growth ETF.

High dividend and dividend growth stocks are outperforming in the current inflationary environment. In addition to the dividend income such companies have quality-characteristics: they display greater financial strength through being more profitable with less stock price volatility.

Today we discuss the Vanguard Dividend Appreciation ETF ( VIG ). Despite its low beta VIG is outperforming the rising stock market.

Factor performance

The past twelve months the best performing equity factors were high div, dividend growth and quality. We discussed all three factors in the past. Our favourite High Div and Dividend growth ETFs are the iShares Core High Dividend ETF ( HDV ) and the SPDR S&P Dividend ETF ( SDY ). Our views on The iShares MSCI USA Quality Factor ETF ( QUAL ) can be read here .

Dividends always play an important role in the total returns of investment portfolios. This is even more the case when the price appreciation of equities is low, as was the was the case the past 12 months.

Companies that are able to consistently pay out dividends are also considered more mature, with stronger cash flows. And this helps both high dividend and dividend growth stocks when stock markets decline. The link with quality is obvious.

And although the stock market return is negative over the past year, the stock market is rising since October of last year. Despite their low beta, some dividend growth ETFs are nevertheless outperforming!

The best performing dividend growth ETF since the lows in October is the Vanguard Dividend Appreciation ETF. With an expense ratio of 0.06% VIG is the cheapest dividend growth ETF.

VIG

The Vanguard Dividend Appreciation ETF tracks the S&P U.S. Dividend Growers Index. This index is designed to measure the performance of U.S. companies that have followed a policy of consistently increasing dividends every year for at least 10 consecutive years.

Dividend-growth oriented stocks have offered lower volatility and reduced downside risk relative to other equity strategies. The consistent and growing dividend payments is a sign of financial strength and discipline and can help to reduce the volatility of an investment portfolio. The S&P U.S. Dividend Growers Index constituents combine a higher return on equity and a higher return on assets with a lower stock price volatility compared to the average U.S. stock. Quality indeed.

In dividend investing it’s important to avoid so-called dividend yield traps. It is possible that a company is high dividend yielder simply through stock price underperformance. The S&P U.S. Dividend Growers Index attempts to avoid these yield traps by excluding the top 25% of the highest-yielding eligible companies.

Research by S&P Global shows that, on average, the highest dividend yielders have historically proven to be yield traps, having achieved their high yielding status through share price underperformance.

These lacklustre returns could point to underlying business instability, with the highest yielders unfavourably changing their dividend policies, on average, at nearly triple the rate of the index constituents for the U.S. index. These potential yield traps tend also to exhibit lower risk-adjusted returns.

Excluding the highest yielding stocks leads to a slightly lower dividend yield for VIG compared to other dividend growth ETFs. But this doesn’t have to hamper total returns of course.

The index design aims to minimize trading costs. To reduce unnecessary turnover, stocks that already exist in the index are only excluded if their yield ranks within the highest 15% (whereas new stocks entering the index are ineligible if they rank in the highest 25% of eligible companies). This helps VIG to be the cheapest dividend growth ETF with an expense ratio of only 0.06%.

VIG and/or SDY?

SDY is our favourite dividend growth ETF. What about VIG? The past months VIG outperformed SDY. This outperformance can be explained by the difference in sector allocation between SDY and VIG.

VIG has more exposure to the well performing Technology sector.

Both SDY and VIG are ETFs with a very long track-record. When we compare their performance since January 2007, we see that the returns are very comparable. On risk measures like volatility and drawdowns VIG is scoring slightly better than SDY which results in a better risk-adjusted performance (e.g. Sharpe ratio).

Especially during the Great Financial Crisis SDY had a worse drawdown probably due to a bigger weight in Financials. Currently SDY’s drawdown is smaller than VIG’s.

Another way to compare both dividend growth ETFs is to check their alpha creation. Also here the difference between the two is very small.

VIG deliberately excludes the 25% highest yielding stocks from its universe of dividend growing stocks and hence has a slightly lower dividend yield compared to other dividend growth ETFs. VIG has a dividend yield of 1.93% and SDY has a yield of 2.52%.

When we compare both ETFs on their long term trend, there is no difference: both are in a long term uptrend.

Both have a good past performance and alpha creation and are in a long term uptrend. VIG is cheaper than SDY, but the latter has a higher dividend yield.

Dividend growers or …. bonds?

Thanks to or due to the higher inflation, interest rates are no longer very low and hence bonds might become more interesting for income-oriented investors.

Unlike dividend stocks, fixed-rate bonds have no inflation protection. When inflation expectations rise, interest rates tend to rise with them as investors demand a higher yield to compensate them for higher expected inflation. As a result, bond prices fall. Dividend growth stocks, which often grow their dividends faster than inflation, do offer some inflation protection.

Additionally, dividend growth stocks offer something bonds lack: income growth.

One can of course expect dividend growth stocks to be more volatile than bonds and to have greater drawdowns.

Investors shouldn’t in our view switch completely from dividend stocks to treasuries, simply because the latter have now a bigger yield. It remains important to look at the total return potential.

Conclusion

High dividend and dividend growth are among the best performing equity factors. While it is always a good idea to invest in high dividend paying equities and dividend growers, this is even more the case in periods with low equity returns.

VIG joins SDY as our favourite dividend growth ETF. Both have a good past performance and alpha creation and are in a long term uptrend. VIG is cheaper than SDY, but the latter has a higher dividend yield.

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