2023-06-26 13:14:07 ET
Summary
- I think SCHD is an overrated ETF. Not a poor one, just overrated. I prefer DJD, an under-the-radar alternative.
- SCHD has attracted a huge following in recent years, despite a lack of compelling long-term advantages. DJD keeps it simple.
- DJD, a dog-of-the-Dow-like approach to equity investing, deserves a closer look by those smitten with SCHD and other huge dividend ETFs.
Let's be clear about this: I don't dislike the Schwab US Dividend Equity ETF ( SCHD ). But I think it is over-hyped, and that many investors will do just as well over the next several years owning one of two ETFs that track the Dow Jones Industrial Average, either through SPDR Down Jones Industrial Average ETF ( DIA ), which tracks the Dow 30-stock index with its quirky price-weighted system, or the smaller, lesser-known Invesco Dow Jones Industrial Average Dividend ETF ( DJD ), which yields about the same as SCHD, has about the same expense ratio, but has underperformed due to the absence of one stock.
That stock, Broadcom Inc. ( AVGO ), whose meteoric rise was captured by SCHD's index methodology a while back, has accounted for a notable portion of SCHD's recent outperformance. Again, I think that's great for SCHD holders. But given the unique, historic runup in stocks like AVGO, currently the ninth-largest component in Invesco QQQ Trust ( QQQ ), I believe that investors may not be sufficiently aware of the risks that SCHD's performance advantage may not be sustained.
I prefer the simplicity and easy look-through of a 30-stock portfolio to a 100-stock portfolio like SCHD. And oh, I do know I'm in the minority in taking that view!
ETF 101: the index is everything
I'll boil it down to this: SCHD is like a lot of dividend ETFs: it is index-based, so it is only as good as the index it tracks. It will have periods where it will do moderately better than peers and other times where it will lag those other dividend ETFs. The chart below shows this versus the most basic of core equity ETFs that are not driven by the FAANG stocks.
However, part of my self-appointed mission in writing about ETFs on Seeking Alpha is to bust investing myths. After all, mutual funds have been around for 99 years. ETFs debuted 30 years ago, but have only recently become very popular.
That's a recipe for oversimplification and misinterpretation. And that, if left unchecked, can result in temporary investor satisfaction, followed by regret.
One frequent myth that I think needs busting is when an ETF gets wildly popular, usually based on a brief spurt of strong performance. Investors come to believe that there is something special about this ETF, something that will provide enduring value versus its peers. Sometimes, that does happen. Many times, it results in disappointment because human nature is to seek safety in numbers.
What's so special about SCHD? Not enough to justify its asset growth
So, we buy what is popular, without truly questioning what the ETF is, what it's trying to accomplish, and what we can attribute its strong performance to. In short, investment "attribution" can be a very misleading aspect of ETF investing. I believe SCHD is a current case study in this, which is why I am taking on this popular ETF.
Here is what has a lot of investors excited about SCHD. The chart below shows the past five years' total return (including dividends) of SCHD, as well as three of the many other ETFs that I consider to be peers of that fund. SCHD is the 5-year winner, hands down. Not that trailing returns should be a main driver of ETF analysis.
Every fund ad says that past performance is no guarantee of future returns. But there is one guarantee about past performance. You can't have it... it's in the past! If you didn't own it during that time, you didn't make that return.
Here's another look at why SCHD's past performance makes for a very nice "selling point." It has more than doubled since the pandemic bottom on March 23, 2020. The other three ETFs have done nicely as well, but SCHD has been the leader.
So, how have ETF investors reacted to this little four-fund peer group since March of 2020? They have poured money into SCHD. It posted performance of around 100%, but its assets under management grew by around 300% over the same time period. Bravo for SCHD, its marketing muscle, or whatever else drove this. For full disclosure, I don't own SCHD, but I have been an investment client of Schwab for over 20 years. And, during nearly all of my career as part of Registered Investment Advisory (RIA) firms before I retired from that business, Schwab was our main custodian, and I hired them on behalf of the firm.
So, what's my beef with SCHD? Nothing that it did. It is, with the perceived safety factor, I think many investors assign to it. In the last 30 days, 19 Seeking Alpha authors have written about it, and about 2/3 of them assigned buy or strong buy ratings. The rest were hold. I have zero issue with any of that.. . as long as investors in SCHD realize that, when you look deeper, this ETF is competitive, but not some buy-and-never-sell type of superstar fund.
The chart shows that SCHD has had some very strong 3-year return periods versus DIA, most of those coming since the end of the pandemic, the period in early 2020 I referenced earlier. Prior to 2020, DIA had a persistent period of outperformance. You can see the difference between the two ETFs in the lower part of the chart. When the purple line is above zero, DIA outperformed SCHD, and when it is below zero, SCHD did better. Perhaps the hype around SCHD has something to do with the historic, though fleeting, period of strong performance versus DIA the past couple of years. As noted earlier, I'm more concerned about a going-forward outlook on SCHD, and for that matter, DIA.
Most equity ETFs are nothing more than indexes that the manager follows to the letter. So, if an ETF does well, it is not because of human intervention. It is because the index had a strong run.
Furthermore, the mix of stocks and the weighting of those stocks within that index is what drives returns. In the case of SCHD, it tracks the Dow Jones Global Select Dividend Index , which is an intelligent and fairly complex scoring system that filters down to 100 stocks. Importantly, it caps individual stock weightings at 4%, and sector weights at 15%. For any investor who has done the due diligence to understand how SCHD chooses and rotates its holdings, I say congratulations. Like I said, I don't dislike SCHD, I just suspect that there has been a piling on effect that is not warranted.
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Here's how AVGO performed the past few years. This is what I'm talking about. Not many stocks that pass dividend index ETF screens end up having moves like this late in a bull market cycle. AVGO was a unicorn, so to speak. Thus, I am skeptical that SCHD will have the good fortune of filtering down to include a rocket-ship move like this one, and be able to hold up to 4% of it in its fund.
AVGO's yield made the cut at the right time, but its price move has knocked that yield down toward 2%.
A longer-term look at the Dow Industrials and the Dow US Dividend 100 Index (the underlying index that SCHD tracks) shows that for the better part of a decade, they have moved in sync. So again I ask, what's all the SCHD hype about? It is like saying a baseball player who hits for a .280 batting average and 20 home runs should be the league's most valuable player. In reality, that player is solid, but not someone to be put in a giant pedestal for putting up those numbers.
DJD: Like Dogs of the Dow, but with 29 stocks instead of 10
I love the Dow because it is only 30 stocks. And because I don't own an ETF until I feel I understand what it owns, how it is allocated and what is likely to drive its price movements in the future, studying 30 stocks is a lot less work than 100. Yes, I'm a concentrated ETF geek.
Below is a comparison of current holdings of DIA and DJD. The two ETFs hold the same names, except that DJD does not own one Dow stock that does not pay a dividend, leaving it with 29 names. DJD simply weights those 29 according to yield, instead of price, as DIA does. It is sort of a "Dogs of the Dow" approach, but without limiting itself to 10 stocks.
etf.com
The much smaller DJD has performed in line with the behemoth SCHD over the past year. AVGO did quite well over this time, but do Apple ( AAPL ) and Microsoft ( MSFT ) which DJD owns, but SCHD doesn't.
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DJD and SCHD: worthy peers, but don't fall in love
So, I like DJD and assign it a Hold rating, because I continue to believe that the broad equity market is treacherous. Not enough to sell it, but not enough to rate it a Buy here. As for SCHD, it also gets a Hold from me, though I will note that its current technical pattern is weaker than DJD.
Finally, I'd encourage investors to know what they own, why they own it, and don't include asset growth and perceived popularity as part of an investment discipline. I think the next few years are going to be a dog fight for equity investors.
For further details see:
SCHD Is Too Popular, I Prefer Lesser-Known DJD