2024-01-03 03:50:18 ET
Summary
- Vanguard High Dividend Yield Index Fund ETF Shares outperformed its peers in 2023 and experienced significant dividend growth.
- VYM has a long-term track record of dividend growth and has become increasingly popular among investors.
- I am bullish on VYM for 2024 and believes it will benefit from a broad market rally and declining risk-free rates.
Investors allocate capital toward individual equities and investment products such as mutual funds and ETFs with different objectives in mind. While one investor's goals may vary from another investor, there is a common objective of not losing money that everyone shares. Investing for capital appreciation often requires a different asset mix than investing to generate income, and while some investors are not too keen on generating dividend income, there is a whole segment of the investment community that has generating income as their main objective. There are many ways to generate income, including investing in equities and selling shares after a certain level of appreciation, utilizing cash to write cash-secured puts on positions you want to own at a cheaper price, writing covered calls against positions within your portfolio, and investing in income-producing assets to collect a dividend. Funds such as the Vanguard High Dividend Yield Index Fund ETF Shares ( VYM ) have become increasingly popular as it finished 2023 with $60.46 billion in assets under management [AUM]. There are many options when it comes to ETFs focused on generating income, and in 2023 VYM performed better than its peers. I have owned VYM for years as a component of an overall income-producing portfolio that I constructed. While I have been hot and cold on VYM over the years, 2023 was the year that VYM earned my respect to keep it in the portfolio, as it was on the chopping block at one point.
Following up on my previous article about VYM
At the end of November, I changed my opinion on VYM as I went from being neutral to bullish. The article can be read by clicking here . In that article, I discussed why I had become bullish on VYM again. Now that 2023 has concluded, I wanted to follow up with another article and discuss how VYM managed to outperform its peers, why I think it will do well in 2024, and why it has regained my confidence as a long-term component of my income-producing strategy.
VYM exceeded my expectations in 2023 by generating significant dividend growth and outperforming its peers
The common reason why investors are allocating capital toward VYM is for the larger-than-average dividend yield. VYM currently pays an annual dividend of $3.48, which is an annual yield of 3.12%. VYM has grown its dividend for 13 consecutive years with a 5-year average growth rate of 5.59%. Throughout 2023, VYM increased its dividend each quarter on a YoY basis and paid investors an additional $0.23 per share compared to 2022. Investors who held VYM throughout 2023 ended up with a 6.96% YoY dividend increase from $2.25 to $3.48. Since its first full year as an ETF, VYM has increased the annualized dividend by $2.12 or 156.3% from $1.36 in 2007 to $3.48 in 2023. VYM has established a long-term track record for dividend growth, and more investors are allocating capital to this low-cost, income-producing ETF as its AUM exceeds $60 billion.
VYM may not have the largest yield or the most appreciation over the past decade compared to iShares Core High Dividend ETF (HDV), Schwab U.S. Dividend Equity ETF (SCHD), iShares Select Dividend ETF (DVY), and the WisdomTree U.S. High Dividend Fund ETF ( DHS ) but it's been incredibly stable and outperformed its peers in 2023 during unique times. When I look at several sectors of the market, which I tracked using different SPDR industry-specific ETFs most of the sectors underperformed the SPDR S&P 500 ETF Trust (SPY). The Technology Select Sector SPDR Fund ETF ( XLK ) led the market as big tech significantly rebounded in 2023. The Communication Services Select Sector SPDR Fund ETF ( XLC ) also outperformed as Meta Platforms (META), Alphabet (GOOGL), and Netflix ( NFLX ) are part of this index. Consumer discretionary also did well, which was tracked by the Consumer Discretionary Select Sector SPDR Fund ETF (XLY), as Amazon (AMZN), and Tesla ( TSLA ) are its top holdings. The rest of the market lagged SPY, and several indexes, including utilities, energy, and consumer staples, finished the year in the red.
In a year where the Magnificent 7 grabbed all the headlines and fueled a 24.73% gain in the S&P 500 and a 53.81% gain in the Nasdaq , many equities were left behind; most of them were income-producing assets. When the risk-free rate of return exceeds 5% and the yield that is generated by most dividend companies found in the S&P 500, there is less of a reason for investors to take on equity risk to generate income. VYM and its peer group faced a rising rate environment, elevated risk-free yields, geopolitical tensions, and worries about debt refinancing, which were all factors that impacted their underlying assets, causing these funds to significantly underperform the S&P. VYM had the least amount of fluctuation in its peer group and ended the year up 2.9% while HDV, DVY, and DHS all finished negative. The combination of VYM's dividend growth and its ability to mitigate risk during difficult periods for its underlying assets are reasons why its AUM continued to grow throughout the year.
Why I am keeping VYM as a component of my income-producing portfolio
I am a fan of diversification as a risk mitigation tool. ETFs are a great way to diversify because you're buying a basket of companies rather than individual equities. My income-producing portfolio is a mixture of ETFs, closed-end funds (CEFs), and individual equities, which include master limited partnerships (MLPs), business development corporations [BDC], and real estate investment trusts [REIT]. I can't time the markets, and I am building out a portfolio that can navigate any business cycle and generate ongoing income while mitigating risk. I don't want to move in and out of positions with these investments unless my investment thesis has changed, and I feel that it's time to cut my losses.
At one point, VYM was underperforming SCHD by so much that I was on the fence about liquidating my position in VYM and reallocating that capital into SCHD. Looking at VYM compared to its peer group on a 5-year chart is a much different result than on a 1-year chart. While VYM outperformed SCHD in 2023, SCHD has outperformed VYM by 19.07% over the past 5 years. I am extremely diversified, so if I were to eliminate VYM, it wouldn't impact my diversification goal, and for some time, I considered exiting the position. SCHD did not perform well in 2023; for most of the year, it was in the red and significantly trailing VYM. While it has outperformed VYM in the long term, I became more bullish on VYM from a risk mitigation perspective. It proved to be less volatile during periods of uncertainty and helped become an anchor in my income portfolio when income-producing assets were underperforming the market. VYM's resilience and strong dividend growth are the main reasons why I have taken it off the chopping block and am once again bullish on this dividend-focused ETF.
I think 2024 will be a strong year for VYM
I think that this time next year, we will look back on the market, and things will look much different than they do today. Most of the gains were produced by big tech, and many equities didn't participate in the rally. I think we're going to see a broad market rally in 2024 as capital flows into the markets from the sidelines, and many underperforming equities will fuel a bull market. I think tech will have another strong year, but I don't think it will be as dominant as it was in 2023.
The last FOMC meeting of 2023 occurred on December 13 th, and Jerome Powell delivered commentary and future predictions. All members of the Fed took an individual assessment as to what they felt would be the appropriate path going forward. The results indicated that the Fed Funds Rate was at 4.6 percent at the end of 2024, 3.6 percent at the end of 2025, and 2.9 percent at the end of 2026. This has caused a further decline in rates as the 10-year finished 2023 at 3.83% after reaching 5%, and the 2-year fall from 5.49% to 4.25%. The CME Group FedWatch Tool is now indicating that the market believes there is a 68.3% chance that rates end 2024 somewhere between 350 bps and 400 bps.
The market could be getting ahead of itself as the Fed held rates higher for longer, unlike what many had expected them to do. The difference is that on the way up Jerome Powell continued to say higher for longer and didn't give any hits that a rate cut would occur in 2023. At the last Fed meeting for 2023, he specifically stated that the Fed believes they are likely to be near or at the peak of its tightening cycle and where the committee members see rates going over the next several years. As of December 7 th, the St. Louis Fed showed that there was a total of $6.14 trillion sitting in money market accounts. The latest numbers from the Investment Company Institute indicate that $256.78 billion or 4.18% of the December 7 th totals have exited money market accounts as there is now $5.89 trillion held between institutions and retail in money markets.
When the risk-free rate of return exceeds 5% risk-free assets such as T-bills, CDs, and money market accounts become a viable option to generate yield. I think that we are going to see an inflow of capital being allocated to income-producing equities and ETFs as the Fed starts to cut rates as there will be less of a reason to keep liquidity in money markets. When the Fed pivots, rates on money markets will decline because they are not fixed for a specific time duration, such as a CD or a T-bill. I think investors will move back into equities and try to get the best yield on the capital they can because they will establish a buy-in yield before any appreciation and get annualized dividend increases from many equities and funds rather than declining yields from risk-free assets. I also think that this will occur for some of the capital that terms from CD and T-bill ladders that were established.
Conclusion
I am bullish on the markets for 2024 and believe that we will get a broad market rally that will positively impact the underlying assets within VYM's holdings and push VYM shares higher. VYM outperformed its peers in 2023 and gave investors a large dividend increase of 6.96% YoY dividend increase from $2.25 to $3.48. I think that VYM will become more desirable as the risk-free rate of return declines, and investors are going to look for diversified ETFs that offer higher-than-average yields with modest dividend growth. I am long VYM as it did a better job of mitigating risk than its peers in 2023 and continues to provide investors with strong dividend growth on an annualized basis.
For further details see:
VYM: 2023 Is Over, And This 3.12% Yielding ETF Is Holding Its Own