2023-08-07 06:19:45 ET
Summary
- The Invesco S&P 500 High Dividend Low Volatility ETF aims to deliver dividend income from low-volatility stocks in the S&P 500.
- SPHD's strategy prioritizes low volatility over high dividends, with securities selected based on volatility first and dividends second.
- While SPHD has delivered price appreciation and impressive total returns over the past decade, we are concerned about how it performed in the last period of heightened volatility.
Background
As we've said here before at Ironside Research, indexing is a great way to gauge the temperature of a market or sector at a glance, to utilize via exchange traded funds [ETFs] to gain diversification in a portfolio, and to participate in a particular sector or industry without having to do the laborious work of picking winners and losers.
But of course, with each advantage come potential drawbacks. Oftentimes the movements of ETFs can be overly influenced by non-fundamental factors, such as algorithmic trading. Sometimes the nature of the way the ETF itself is structured can lead to unintended effects.
Today we evaluate the Invesco S&P 500 High Dividend Low Volatility ETF ( SPHD ). In this article we'll analyze the fund, how it is structured, potential drawbacks, and our outlook for its holdings.
Let's dive in.
The Strategy
SPHD belongs to a niche of ETFs that seeks not to capture the returns of the wider index that it tracks. Adding a layer of complexity, SPHD aims to achieve two things--deliver dividend income, and find dividend income from the stocks with the lowest realized volatility in the S&P 500. This is done by tracking an index within an index--the S&P 500 Low Volatility High Dividend Index.
The summary prospectus outlines how the sub-index is constructed, which is an important thing for shareholders to understand:
Strictly in accordance with its guidelines and mandated procedures, S&P Dow Jones Indices LLC (the “Index Provider”) compiles, maintains and calculates the Underlying Index, which is designed to measure the performance of the 50 least volatile high yielding constituents of the S&P 500 Index in the past year. The Index Provider identifies the 75 securities in the S&P 500 Index with the highest dividend yields over the past 12 months, with no one sector within the S&P 500® Index allowed to contribute more than 10 securities. From those 75 securities, the Index Provider selects for inclusion in the Underlying Index the 50 securities with the lowest realized volatility over the past 12 months... The Underlying Index weights each constituent security by its trailing 12-month dividend yield, with higher dividend-yielding securities receiving proportionally greater weights.
Essentially, Dow Jones Indices creates a basket of 75 securities from the S&P 500 which are primarily low volatility, and then sorts them based on dividend yield.
This is important. We have a hunch that a lot of investors drawn to SPHD see the 'High Dividend' component as being the primary, while 'Low Volatility' gets second billing. Volatility, after all, isn't as attractive an investing concept as dividends, generally. However, it is in fact the other way around--securities in SPHD are selected for volatility first , and dividends second .
For example, as of this writing the highest yielding dividend paying stock in the S&P 500 ( SPY ) is Pioneer Natural Resources ( PXD ), with a current indicated yield of 11.7%. SPHD's largest holding is Altria ( MO ), which as of this writing has a dividend yield of 8.5%. Pioneer, due to its volatility, is excluded from SPHD. We want to be clear that we are not making a judgment on this strategy, but rather simply want to ensure that shareholders have a solid grasp on what they own.
We'll make an assumption that most investors in SPHD aren't expecting to beat or match the broader market's performance, which would be a good thing since the goal of the fund is to match the sub-index it mirrors. In this is has largely accomplished its goal:
Over the last ten years SPHD has delivered a little more than 40% in price appreciation for shareholders. On a total return basis (which assumes dividends have been reinvested), the figure jumps to a more impressive 117%.
What Are The Risks?
Anytime one invests in an index one assumes a degree of index risk. Investing in an index of an index carries an additional degree.
We already know that the stocks included in the SPHD have the lowest realized volatility of the S&P 500, but we have to account for the fact that the individual equities are still a part of the S&P 500 and therefore subject to the index risk associated with the S&P 500. In other words, the low volatility can still be impacted or raised by broader market swings.
The largest risk of which we know in this case is brought on by algorithmic trading and the daily rebalancing of the multitude of enormous ETFs and mutual funds which track the S&P 500. Large swings in constituent stocks of the index (which, we remind readers, are largely dominated by the biggest tech names), can have a ripple affect across the largest index as these large institutional firms rebalance at the end of the day across the market, introducing the potential for volatility where it may not be expected.
Consider the above chart, which overlays the CBOE VIX Index in blue ( VIX ) against the S&P 500 In orange ( SPY ) and SPHD in bold yellow. During times of high volatility in the market, the VIX spikes.
Examine the time on the chart at the start of the pandemic, when the VIX spiked almost 600%. At that time, SPHD and SPY were roughly moving in tandem. From January 1st 2020 until April 1st 2020 (the time in which the VIX spiked), SPHD experienced a 34% decline, while SPY experienced a 24% decline.
In other words, the expectation of low volatility doesn't always translate to more stable performance when high volatility strikes.
The Bottom Line
Index funds can be great ways to diversify one's portfolio and avoid the arduous task of picking individual winners and losers. As of this writing, SPHD has an indicated dividend of 4.23% (see below).
For the market risk shareholders are taking, we find the dividend to be a bit insufficient, especially in an age when the two year treasury yields 4.9% as of this writing. Further, the performance of the fund relative to SPY during the last period of heightened volatility does not give us comfort. For now, we must remain on the sidelines for SPHD.
For further details see:
SPHD: The Dividend Isn't Worth The Risk