2023-11-28 19:59:31 ET
Summary
- Vanguard High Dividend Yield ETF has a more pronounced allocation towards high-yielding stocks compared to the S&P 500. Majority of these holdings are large cap value names.
- The ETF offers diversification and limited credit risk, but lacks an attractive dividend yield relative to other alternatives.
- VYM has underperformed the S&P 500 and its yield has remained flat despite an increase in the Fed Funds rate, making it less appealing to investors.
- I find no reason to consider going long on VYM.
Vanguard High Dividend Yield ETF ( VYM ) is a passive ETF, which has an allocation strategy that is skewed towards more high yielding stocks than the average names that are included in the S&P 500.
There are no additional policies or tactics incorporates in VYM that stretch beyond a pure play long strategy of selected quality large-cap value companies.
If we look at the portfolio composition, we can clearly notice several common patterns that are present among many liquid and rather conventional ETF structures.
For example, the number of holdings is quite significant with over 450 companies included in the mix. The Top 5 names account for roughly 12% of the total AuM. So, there is a great degree of diversification embedded in the strategy, which effectively neutralizes any major idiosyncratic risks.
Moreover, there is no particular focus on certain sector. However, if we sum together energy, financials and consumer staples we could perhaps argue of some minor concentration in rather volatile segments of the economy.
However, if we peel back the onion a bit, the underlying allocations on a security-level are safe with limited credit risk. For example, almost all of the Top 10 holdings carry investment grade balance sheets and huge market capitalization levels, which all together decrease the speculative nature of VYM's position.
Thesis
While VYM could safely be deemed as a defensive investment, there are a couple of issues with this investment.
First of all we have to appreciate the fact that the current dividend yield that is offered by VYM is not that attractive relative to the S&P 500 (and not even speaking of the U.S. Government or high quality corporate fixed income alternatives).
There is less than 200 basis points of spread relative to the yield that is generated by the S&P 500. Plus, in absolute terms 3.16% dividend yield is not high by any means in the context of current interest rate environment.
In my opinion, this is a problem considering that the main investment objective of VYM is to provide high yield that is attractive enough to motivate yield-seeking investors to reorient parts of their capital into the ETF from other lower yielding alternatives.
Second, another area of concern is that since the start of a more aggressive Fed interest rate policy, VYM's yield has remained flat despite an uptick of ~500 basis in the Fed Funds rate. Basically, the relative attractiveness of VYM as a safe yield-providing vehicle has considerably declined since early 2022.
Third, the fact that VYM has constantly underperformed the S&P 500 on a total return basis does not send a comforting signal to investors, who might be willing to enter a long position in order to capture a ~200 basis points of additional yield.
Finally, one might argue that VYM embodies a solid case against the backdrop of falling interest rates. Now, when the overall market consensus is skewed towards experiencing a normalization in the Fed Funds rate, investments, which have previously been depressed due to elevated cost of financing or that have gone down due to a notable exposure in duration factor, should benefit nicely from any interest rate cuts.
However, in my view, this is not the case with VYM. The issue is that VYM is inherently biased towards large cap value stocks, which per definition are less sensitive (compared to growth stocks) to the changes in the interest rate dynamics. Plus, in many instances some positions within VYM portfolio have actually benefited from the recent environment as the inflationary pressures have enabled higher pricing on their products (e.g., credit and energy).
The bottom line
While VYM could be deemed a safe investment due to a diversified portfolio, where the allocations are made into well capitalized value companies with solid balance sheets, it fails to provide an attractive offering to investors.
VYM is supposed to offer an attractive yield that could motivate investors to consider such exposure, but considering that the spread in yield compared to the S&P 500 is very minimal and that the yield has not changed since the early 2022, I find it difficult to find a meaningful reason to allocate into VYM.
For further details see:
VYM: High Dividend Yield ETF With A Subpar Offering