SPHD: Dividend ETF May Be Poised To Overtake SCHD

In a vibrant investor community like Seeking Alpha, if your thesis is that of a “yield-hog” ETF like the Invesco S&P 500 High Dividend Low Volatility ETF (NYSEARCA:SPHD) shows strong signs it may soon reverse its underperformance versus a favored dividend ETF like Schwab U.S. Dividend Equity ETF (SCHD) you better have some evidence. As the classic expression goes, “if you come at the king, you best not miss.”

I’ll leave it to the comments section for readers to tell me how much they agree with this analysis. But to me, as a dividend investor, I want dividend yield. SPHD delivers that, SCHD does as well, but consistently to a lesser degree. During periods of high potential price appreciation in the stock market, that desire for yield as part of the total return is reduced. And that has been the case for several years now. But the clock is ticking on dividend strategies that are really more like growth strategies with an above-average yield.

And while SCHD has done extremely well over the past few years, I think there’s an excellent chance its style does not fare as well in the environment we are transitioning to. That is one where dividend investing is more about yield that is sufficiently high and where price volatility is low. I think SCHD is still a solid dividend ETF, but going forward, I prefer the precision and focus that SPHD offers. I think they can also be used together. But my bottom line is that for the next 2-3 years, which is as far out into the future as I’m willing to look, I prefer SPHD to SCHD. And frankly, the fact that their ticker symbols only differ very slightly understates just how different they are.

SPHD: an index ETF that thinks more like an active manager – ER comparatively low

Since 1960, reinvested dividends have made up 84% of the S&P 500’s total return. At first glance, investing in a mature company with predictable income might seem like the less glamorous option, especially in the growth-obsessed market we’ve seen in recent years. But capital appreciation combined with steady dividends has proven consistently to be a solid, long-term investment strategy.

The “recency effect” has psychologically worked against dividend ETFs, except for those that actually carry more of a hybrid dividend/growth style. SPHD is a dividend-focused, dividend first ETF that combines the hunt for yield with a preference for companies that historically have exhibited lower volatility. Because when I prioritize dividend yield, the last thing I want is big drawdowns in key parts of my portfolio. That is one of the key tenets of my Yield At a Reasonable Price (YARP) dividend equity approach, described in recent articles. I apply YARP to dividend ETFs as well. And I like what I’m seeing from SPHD in that regard.

Here’s the key starting point for my YARP system. SPHD’s yield is near the top of its 7-year range. And it is starting to dip lower, coinciding with a price trend that (not shown) is threatening to break out of a fairly lengthy downtrend. YARP is ideal for equities and while not as sharp for ETFs, it is still quite effective, I have found. And with SPHD, I am looking out a few years, so my precision level in “calling a breakout” in this ETF is not the priority here.

SPHD’s philosophy is to invest in high-yield, low-volatility investments, so it comes as no surprise that it is overweight defensive stocks and underweight more volatile tech and consumer cyclical companies.

SCHD has more than double the weight of SPHD in those 2 sectors, and is notably lighter in many traditional defensive sectors. That has fed its recent success, but I think it has also promoted a sense of overconfidence in its shareholder base. To be clear, I think SCHD is an OK ETF, but now at $53 billion in assets, it risks losing flexibility to own some stocks that could be return-savers. I am concerned that its AUM-gathering success is part past performance and part cult behavior, in an investing sense. Neither is as likely to be a winning approach in the next few years, as inflation likely remains elevated, and the market potentially re-discovers true dividend ETFs like SPHD.

Higher rates may finally bite in 2024-2025

Generally, higher rates hurt stock market performance because it costs more to borrow money needed to grow companies, or fund acquisitions, eating into company profits. Thanks to high rates and inflation, in 2023 alone we saw 600 corporations file for bankruptcy, some of the highest numbers we’ve seen this past decade. And, given that inflation is still above 3%, I don’t believe the Fed will cut rates before June of this year, meaning more companies and consumers will have to borrow at higher rates. This will increase the debt load of corporations, especially with a “refinancing cliff” due to envelop many firms by 2025. That seems to be a recipe for a shift from what has worked in the dividend space to what used to work, before the Fed saved the US economy in 2016 and went on a path to “QE infinity” until 2022.

Because of my somewhat bearish outlook on the markets, I want to de-emphasize growth sectors and reconsider defensives and industrials.

Concentration: a key to my affection for SPHD

I like my ETFs concentrated when I can get them that way. SPHD has half as many stock holdings as SCHD (52 to just over 100). And at a time when I prefer more proactive rotation within an equity portfolio, SPHD offers a turnover rate that looks more like an actively managed fund, though it isn’t.

As for SCHD, I can unmask its success over the past 3 years with one chart, this one. Here’s what I see: its total return has very closely mimicked that of an ETF that is more concerned with how many years a stock’s dividend has been raised than how much it will pay me now and in the foreseeable future, as a percent of my investment. In other words, SCHD has been aided by the relative strength of “dividend aristocrats” and I think that era is transitioning back toward higher yielders.

And that’s another reason why SPHD, which has consistently had a yield advantage, is a dividend ETF I favor. That yield advantage narrowed in the immediate post-pandemic period, but as shown below, it has widened very nicely. 4.5% looks a lot better to me than 3.4% when T-bills yield 5%.

Here’s another way to analyze the differences between the 2 ETFs, using “attribution” analysis from YCharts. Here are the top contributors and detractors of SCHD over the past 5 years. I see some stocks in here that have had decent tailwinds, but that are not likely to produce nearly enough yield to qualify for my dividend ETF “bucket.”

Now, here’s the same analysis over the past 5 years for SPHD. Sure, there is a bit of overlap. But these are more of what I consider to be classic dividend stocks.

Finally, a holdings chart reads like this: on the left are the stocks SCHD holds much more of than SPHD, and on the right, the opposite is the case. Yes, there are some currently “ugly” stocks on the right, but part of the market’s next phase could quite possibly see a renewed interest in those beaten-down yielders, which have been a huge performance drag on many income portfolios.

SPHD: a buy for me, on a 2-3 year outlook

I’ve owned it before, and I like the idea of building a position here, with a 2-3 year outlook. In my personal portfolio, I may build a much smaller position in the ETF itself and choose to overweight some stocks, but I mention that just parenthetically to explain how I use dividend ETFs and YARP-dividend stocks in tandem.

Although I consider this a buy, as always, there are some downsides to this ETF. The biggest would be that, as some pundits like to say, “this is 1995.” That was a period following a series of 7 rate hikes in 1994, which not only did not crush the stock market, it opened the proverbial floodgates and created the dot-com bubble. Maybe AI is a repeat of that era, and not what drives the broad market into the ground as was the case in 2000, after the bubble popped.

I am not going to get too caught up in the timing, and simply conclude that SPHD is a solid core dividend ETF holding for someone like me that looks at dividend ETFs and thinks “dividend” is not “a decent dividend, but make sure I have some hot growth stocks to pump up performance when the market gets irrational.” I’d rather separate the 2 concepts. So SPHD gets the Buy rating with a 2-3 year time frame in mind.