REGL: There’s Only One Good Reason To Buy This Mid-Cap Dividend Aristocrats ETF (BATS)

Investment Thesis

This article continues my coverage of the ProShares S&P MidCap 400 Dividend Aristocrats ETF (BATS:REGL), a mid-cap value fund comprised of 50 U.S. stocks that have raised dividends for at least 15 consecutive years. For those catching up, my August 31, 2023, review was not positive, and I predicted REGL would lag higher-quality peers, particularly the Invesco S&P MidCap Quality ETF (XMHQ). Indeed, REGL’s total return was 10% lower, but REGL’s best feature is consistent outperformance in bear markets, and the purpose of this article is to determine whether that feature offsets other weaknesses like low 4.53% free cash flow margins and a 2.47% dividend yield easily found among large-cap ETFs. In my view, these weaknesses are too much to overcome, but I look forward to presenting the performance and fundamental data in detail below, and as always, I welcome your feedback in the comments section afterward.

REGL Overview

Strategy Discussion

REGL tracks the S&P MidCap 400 Dividend Aristocrats ETF, selecting U.S. mid-cap companies with at least 15 consecutive years of dividend increases. The fund’s website and fact sheet indicate these companies are high-quality with “strong histories of profit and growth” and can weather periods of market turbulence by “capturing most of the gains of rising markets and fewer of the losses in falling markets.” Indeed, through December 31, 2023, REGL has delivered an annualized 9.40% return since its inception compared to 9.13% for the S&P MidCap 400 Index. The performance gap would be wider, but REGL’s 0.35% expense ratio is significant and the primary source of tracking error between the ETF and Index’s returns.

Based on this table, the contention that REGL can capture most of the gains of rising markets is questionable. The SPDR S&P 400 MidCap ETF (SPMD) beat REGL by 11.03% in 2023 (16.47% vs. 5.44%), and REGL’s best performance in a drawdown was from September – December 2018 when it outperformed SPMD by 10.47%. Therefore, REGL is simply a less volatile mid-cap value fund, but in fairness, its long-term returns and risk-adjusted returns are superior to SPMD. As shown below, RELG’s volatility, measured by standard deviation, is 15.24% compared to 19.17% for SPMD, leading to far better risk-adjusted returns (Sharpe and Sortino Ratios).

Performance Analysis

The above table suggests that REGL is a better choice than SPMD. However, SPMD is a relatively easy benchmark to beat. In fact, from February 2015 to January 2024, SPMD’s 95.72% total return ranked #28/35 in the mid-cap category. REGL’s 113.06% total return ranked #9/35, but it’s crucial to know that its annual return rankings are inconsistent. The data below throws cold water on ProShares’ contention that REGL can capture most gains in rising markets, as evidently, it does far better in down markets (e.g., 2015, 2018, 2022). It was a bottom-quartile performer in rising markets like in 2017, 2020, 2021, and 2023.

• 2015: -0.05% (#2/35)
• 2016: 28.64% (#3/35)
• 2017: 10.17% (#34/35)
• 2018: -3.26% (#3/35)
• 2019: 18.41% (#34/35)
• 2020: 7.52% (#24/35)
• 2021: 19.39% (#25/35)
• 2022: -0.61% (#1/35)
• 2023: 5.44% (#34/35)

The following table summarizes annual return data for the 35 mid-cap funds used to calculate these rankings. I’ve also included a column highlighting each fund’s average annual ranking, as consistency is key for ETFs designed for the long run.

REGL’s average rank between 2015 and 2023 was just #18/35, or right in the middle of the sample. ETFs like the Invesco S&P MidCap Momentum ETF (XMMO) and the Invesco S&P MidCap Quality ETF (XMHQ) proved better, both cumulatively and on average return rank. In particular, XMHQ ranked #8, #23, #16, and #2 from 2020-2023, its first four whole years since its Index change in June 2019, and it’s this knack for avoiding bottom-quartile performance in any given year that makes it unique. Index ETFs like SPMD also avoid bottom-quartile performance but have never ranked in the top quartile.

The purpose of this section was to highlight the many options available to mid-cap investors. On total returns, there are several better options. On the other hand, REGL has the edge during downturns, so a lot depends on your investment approach and general market outlook. Also, you’ll need to assess your income needs and how well REGL satisfies them, so let’s look at its dividend features next.

Dividends

Seeking Alpha’s Dividend Page for REGL highlights many important metrics, including its trailing 2.43% dividend yield and 10.31% five-year dividend growth rate. Although its dividend growth streak stopped in 2022, this double-digit growth is challenging to find among mid-cap ETFs.

The 10.31% rate ranks #15/69 among the mid-cap ETFs I track, and #4/15 among those with dividend yields above 2%. The three others are as follows:

• First Trust SMID Cap Rising Dividend Achievers ETF (SDVY): 17.69%
• First Trust Mid Cap Value AlphaDEX Fund (FNK): 10.88%
• JPMorgan Diversified Return U.S. Mid Cap Equity ETF (JPME): 10.51%

Since November 2017, when SDVY launched, these ETFs have outperformed REGL but proved far more volatile. Again, that’s the calculation each investor will need to make. Is your main objective to enhance total returns, lower risk, or build a growing income stream you can take into retirement?

Also, consider how quickly you plan on accessing that income stream. Many investors choose to reinvest dividends, but as the chart below shows, REGL’s portfolio income advantage has shrunk over the last five years.

In 2018, a $10,000 investment generated $200 compared to $162 and $132 for JPME and SDVY. In 2023, REGL’s portfolio income grew to $324, but SDVY’s increased to $325, and it’s no coincidence it was also the best performer over this period. Remember that dividends are paid out of earnings, and companies growing those earnings quickly typically are rewarded with higher stock prices. That is why it’s a mistake to think dividends and capital gains are mutually exclusive. Put differently, for REGL’s dividend growth strategy to work, its constituents have to generate acceptable earnings growth to support dividend growth, so let’s take a look at those fundamentals next.

REGL Fundamentals

The following table highlights selected fundamental metrics for REGL’s top 25 sub-industries, totaling 88.78% of the portfolio. Despite equal weighting its constituents, this concentration highlights REGL’s poor diversification. Gas Utilities and Regional Banks comprise almost one-quarter of the fund, and Financials and Utilities combine for over 50%. These sectors falling in and out of favor explain REGL’s inconsistent performance.

Here are some additional observations:

1. REGL stands out for its low 0.84 five-year beta, consistent with how the ETF has performed historically. Gas Utilities and Property & Casualty Insurance stocks are defensive plays, and there aren’t many sub-industries with betas above one. This directly contrasts with how SPMD, JPME, and XMHQ are structured, and if lowering risk is your primary objective, REGL is a reasonably safe bet.

2. The forward dividend yields listed are Index yields, meaning they aren’t adjusted for fees. After subtracting REGL’s 0.35% expense ratio, shareholders should expect a 2.47% yield at current prices compared to 1.50%, 2.00%, and 0.65% for SPMD, JPME, and XMHQ. While REGL’s net yield is about as good as it gets for the mid-cap category, it’s not very high, and I suggest investors consider other ETFs for income purposes. In the large-cap category, higher-yielding funds include:

• Schwab U.S. Dividend Equity ETF (SCHD)
• Vanguard High Dividend Yield ETF (VYM)
• iShares Core High Dividend ETF (HDV)
• WisdomTree U.S. High Dividend ETF (DHS)

Considering your income source is similar to the asset allocation decisions you already make between stocks, bonds, cash, and alternatives. These large-cap ETFs offer a higher starting yield and are of higher quality, and they’re better suited to drive the income segment of the equity portion of your portfolio.

3. REGL trades at 17.45x forward earnings and 12.56x trailing cash flow, the lowest in this sample. However, JPME is just a little behind at 18.65x and 14.31x, and as its name suggests, it’s well-diversified. Only 51.60% of its assets are in its top 25 sub-industries, compared to 88.78% for REGL. This stronger diversification results in more consistent and predictable returns, which I’ve verified by ranking its annual returns from 2017-2023:

• 2017: 19.08% (#15/39)
• 2018: -8.90% (#13/42)
• 2019: 25.88% (#28/42)
• 2020: 8.40% (#29/44)
• 2021: 28.89% (#12/53)
• 2022: -10.12% (#14/62)
• 2023: 11.28% (#60/65)

Except for last year, JPME avoided the bottom quartile. Even with the previous year’s dismal performance, it’s still beat REGL since inception on returns and risk-adjusted returns.

4. A big red flag is REGL’s 4.53% free cash flow margins, indicating that significant dividend growth is unlikely. A 6.57/10 profit score confirms REGL isn’t a high-quality fund, and I suspect that if its constituents raise dividends at the 7.40% five-year rate they’ve had over the last five years, REGL’s share price will suffer. Again, large-cap ETFs have more “wiggle room” because they’re typically more profitable with higher free cash flow margins. Profit scores and free cash flow margins for the four large-cap funds mentioned earlier are as follows:

• SCHD: 9.34 / 16.05%
• VYM: 8.98 / 10.84%
• HDV: 9.53 / 13.99%
• DHS: 7.77 / 12.18%

Investment Recommendation

REGL has a proven track record of outperforming in bear markets, ranking in the first quartile in 2015, 2018, and 2022. Its 0.84 five-year beta is much lower than its mid-cap peers, and given its high allocation to Utilities, it should also do relatively well during the next market decline. However, I don’t find its dividend yield compelling, and I am concerned with its 4.53% free cash flow margin and mid-single-digit earnings growth rate, which indicates limited dividend growth moving forward. Since it’s too difficult to predict the timing of recessions, XMHQ is the smarter mid-cap play, and you can turn to large-cap ETFs for higher dividend yield and dividend growth potential. Thank you for reading, and I look forward to your comments below.