Investing In Dividend Aristocrats, But Getting A 5% Yield

David Dierking

The eternal struggle for income-seeking investors is the lack of options for achieving higher yields. Both the S&P 500 and long-term Treasuries earn less than 2%. Even high yield stocks only get you in the 3-4% range.

Getting a yield above that often requires targeting riskier segments of the market, such as junk bonds or MLPs.

But there is an ETF out there that combines the relatively conservative risk profile of long-term dividend growth stocks with a nice high yield.

The CBOE Vest S&P 500 Dividend Aristocrats Target Income ETF (KNG) invests in a portfolio of long-term dividend growth stocks, but also layers on a covered call strategy aimed at delivering a yield that's 3% above that of the S&P 500.

Objective & Strategy

The strategy aims to deliver on its objective by:

  • Prudent stock selection, targeting economically advantaged companies that consistently raise their dividends while growing fast enough to keep ahead of inflation, and
  • Selling call options on no more than 20% of each holding to augment income to a targeted level.

From a standpoint of composition, KNG is an equal-weighted portfolio of S&P 500 companies with a minimum 25-year history of consistently raising their dividends.

The written call options are typically about one month until expiration and are roughly at-the-money.

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Given the S&P 500's current yield of 1.8%, that equates to a targeted KNG yield of 4.8%

Risks

The risk with any covered call strategy is that it tends to limit upside potential, due to the likelihood of in-the-money call options being exercised by the buyer, but allows for unlimited losses in down markets.

We can see how this has played out over KNG's 2-year history when compared to both the S&P 500 and its counterpart, the ProShares S&P 500 Dividend Aristocrats ETF (NOBL).

^SPX_^MID_^SML_XLC_XLK_XLI_XLB_XLF_XLY_XLU_XLRE_XLV_XLP_XLE_TLT_IGPUSD_KNG_NOBL_chart

KNG has indeed underperformed both the S&P 500 and NOBL, especially during the period of rising share prices. The added option income received during the 2020 bear market wasn't even enough to offset losses versus the S&P 500 since dividend stocks, in general, lagged the broader market.

But investors should find the yield here relatively enticing and the fact that its coming on the back of a dividend aristocrat portfolio is even more attractive.

Considering that junk bonds are currently offering roughly the same yield, I would much prefer the durable nature of long-term dividend growth stocks over the bonds of financially distressed companies.

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