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Hybrid Funds To Complement High Yield Portfolios

Complementing high-yielding portfolios with three funds that capture the essence of dividend investing and generating capital appreciation.

There are all types of income investors. Some are focused solely on generating high yields from their deployed capital, while others build out portfolio’s trying to replicate similar returns that the market produces while squeezing out more than 1.37% in annual yields. When looking for income, many investments such as Alphabet (GOOGL), Amazon (AMZN), Tesla (TSLA), and Facebook (FB) are off the table as they don’t generate dividends. Without exposure to high-growth companies, income investors will have difficulty replicating average market returns in a bull market. I like using the SPDR S&P 500 Trust (SPY) as my barometer for comparing different investments to the market as it’s the most recognized S&P 500 index fund. Over the past five years, SPY has appreciated by 120.21% while generating an annual dividend of $5.66 per share, a forward yield of 1.23%.

Many income investors have searched for investments to offset the loss of capital appreciation that income investing often inflicts on a portfolio. Not every income investor wants to dedicate their portfolio to high-yielding investments and some are looking for hybrid investments that can offer significant capital appreciation while yielding more than a standard index fund. Recently I wrote an article on three high-yielding funds from Global X that I own and have built a high-yielding portfolio around. Investing in an ETF such as the Global X Nasdaq 100 Covered Call ETF (QYLD) isn’t for everyone as the sacrificing of capital appreciation for the high yield it produces doesn’t work within their investment thesis. For the income investor that is looking to generate above-average market yields and still benefit from capital appreciation, I have a combination of three ETFs that could fit right in your income-producing portfolio. The combination of the Schwab U.S Dividend Equity ETF (SCHD), iShares Core Dividend Growth ETF (DGRO), and the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) provides exposure to 562 holdings, has an average yield of 2.24%, and have an average appreciation of 90.16% in the last five-years.

(Source: Seeking Alpha)

(Source: Seeking Alpha)

SCHD generally invests in stocks that are included in the Dow Jones U.S. Dividend 100 index. This subset of the Dow Jones U.S. Broad Market Index excludes real estate investment trusts (REITs), master limited partnerships, preferred stocks, and convertibles. SCHD is a market-cap-weighted fund using fundamentals such as cash-flow to debt ratio, ROE, dividend yield, and dividend growth rate to construct its investment portfolio from the Dow Jones U.S. Dividend 100 Index. SCHD is rebalanced quarterly to make sure its positions meet the 4% and 25% criteria, and the overall composition is reviewed on an annual basis.

As a dividend fund, I am fond of SCHD because it still generates a forward yield of 2.88% even after a recent capital appreciation. SCHD has a low expense ratio of 0.06%, has $28.86 billion in assets under management, and has generated a return of 89.33% in the last five years. In SCHD’s top holdings, you will find companies such as Merck & CO (MRK), The Home Depot (HD), Verizon (VZ), Broadcom (AVGO), Cisco Systems (CSCO), PepsiCo (PEP), and Coca-Cola Company (KO). SCHD has paid a dividend for nine consecutive years, has three consecutive years of dividend increases while having a five-year CAGR of 14.55% and a three-year CAGR of 17.40%. SCHD provides investors with respectable capital appreciation, a large dividend yield, and double-digit CAGRs. This hybrid fund can help replace the loss of capital appreciation in a high-yielding portfolio while still throwing off a sizable dividend that continues to grow.

The iShares Core Dividend Growth ETF or DGRO is another great choice for income investors. Unlike SCHD, DGRO has Apple (AAPL) and Microsoft (MSFT) in its top ten holdings. Of the three ETFs I discuss in this article, it has the largest capital appreciation over the past five years generated a 98.39% return. DGRO offers investors a fund predicated around U.S equities that have a history of consistently growing their annual dividends. The criteria for inclusion in DGRO are that the equity must pay a qualified dividend, have at least five years of uninterrupted annual dividend growth, and their earnings payout ratio must be less than 75%. DGRO has an emphasis on technology as 17.19% of the portfolio is allocated to this sector which has benefited its returns throughout the bull market.

DGRO pays an annual dividend of $1.05, which is a forward yield of 1.97%. DGRO has paid consecutive dividends for six years and has also increased its annual dividend consecutively for six years. In the past five years, DGRO has had a CAGR of 19.28%, and in the past three years, the CARG has been 9.14%. The culmination of a dividend that has fluctuated around 2%, significant capital appreciation, and significant dividend growth makes DGRO a strategic addition for a high-yield portfolio that is missing upside potential while still providing yield and dividend growth. DGRO also has a low expense ratio of 0.08%, allowing investors to gain exposure to world-class management at an ultra-low rate.

The third fund in this combination is the ProShares S&P 500 Dividend Aristocrats ETF, NOBL. This is an enticing fund for many individuals as its constructed from only companies that have gained Dividend Aristocrat status. Today there are 65 members in this exclusive club, and to achieve being a member, a company must be included in the S&P 500 index, have 25+ consecutive years of dividend increases, and maintain minimum size and liquidity requirements. Many investors look to the companies within NOBL as individual investments because of their dividend credentials. NOBL has created a fund specifically around these benchmarks, making it a highly sought-after dividend fund. While only the largest S&P 500 companies that have paid a dividend that has increased for 25+ years are part of NOBL, this fund has generated an 82.77% return over the past five years. Part of the appeal is that for a company to pay a growing dividend for 25+ years, it usually means that they have demonstrated a history of weathering market turbulence over time.

NOBL holds all 65 dividend aristocrats in its fund with several dividend kings. 3M (MMM), KO, Johnson & Johnson (JNJ), Proctor & Gamble (PG), Colgate Palmolive (CL), Dover Corp (DOV), Genuine Parts Company (GPC), Emerson Electric (EMR), Stanley Black & Decker (SWK), and Hormel Foods (HRL) have all paid dividends that have consecutively increased for more than 50 years. Within NOBL, you will find more than half the holdings have grown their dividends for more than 40 consecutive years. NOBL has paid a dividend for seven years and has also provided seven consecutive years of dividend increases. NOBL’s five-year CAGR is 11.61%, and over the past three years, its CAGR has been 8.26%. NOBL can fit into any income portfolio as it provides exposure to sixty-five of the highest quality dividends while still providing significant capital appreciation.

Income investing can certainly lack exposure to capital appreciation, but that’s not the case with SCHD, DGRO, and NOBL. These three ETFs are some of the best hybrid funds in the market and can become a pivotal addition to any income portfolio. Many income investors sacrifice capital appreciation for yield, but you can add both future growth potential and respectable yields to the portfolio with these three investments. Regardless if you’re in the market for a fund with only the most battle-tested companies in NOBL, a fund that focuses on capital appreciation and dividend growth in DGRO, or a fund that is a true hybrid providing a high yield of around 3% while still generating an 89.33% return over the past five-years in SCHD, any of these funds can complement a high-yielding portfolio. Sometimes you can have it all, and these funds provide the best of both worlds where dividend investing and capital appreciation collide.

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