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VIG vs. NOBL vs. SDY: Does Adding High Yield Help A Dividend Growth Strategy?

It's been a tough time lately for SDY, but conditions could finally be swinging in its favor.

If you've been a dividend income investor over the past several years, it's been some rough sledding. Not since the first half of 2016 have dividend stocks been able to deliver any kind of extended stretch of outperformance relative to the S&P 500. It's mostly been underperformance since then and, in the case of the 2020 post-COVID recession recovery, severe underperformance.

The yield environment, of course, hasn't helped matters any. The S&P 500 (SPY) is earning a scant 1.2% today. If you target dividend growers, you can do a little better. The two most prominent dividend growth ETFs, the Vanguard Dividend Appreciation ETF (VIG) and the ProShares S&P 500 Dividend Aristocrats ETF (NOBL), yield 1.6% and 1.9%, respectively. Again, it's a modest improvement, but still not enough to get too excited over.

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There is a third option in the dividend growth space - the SPDR S&P Dividend ETF (SDY). It too targets long-term dividend growers, but yield-weights the portfolio instead market cap-weighting. The resulting portfolio yields 2.6%.

Higher yield, however, equates to higher risk and SDY is no exception here. High yielders can be high yielders for a reason. The share price, for example, may have dropped due to any number of reasons and the yield is artificially high at the moment. It could potentially be at risk for a dividend cut, although the wide scale COVID-related risk of dividend cuts appears to have minimized.

Is it worth it to take a step up in risk to pursue a higher yield in the dividend growth universe? Let's put VIG, NOBL and SDY side by side to see how they line up next to each other.

Vanguard Dividend Appreciation ETF (VIG)

VIG tracks the S&P U.S. Dividend Growers Index. This index includes targets U.S. companies with a minimum 10-year track record of paying and growing their dividends.

It does make a couple of notable exclusions from its universe. REITs are ineligible, while the top 25% highest ranked eligible companies from the index universe are excluded from index inclusion.

ProShares S&P 500 Dividend Aristocrats ETF (NOBL)

NOBL tracks the S&P 500 Dividend Aristocrats Index. It simply targets the components of the large-cap index that have grown their dividends for at least 25 consecutive years.

The portfolio is equal-weighted and re-weighted once a quarter. The index maintains a minimum of 40 stocks (there are 65 currently) and can dip below the 25-year threshold if there aren't at least 40 names meeting the traditional "dividend aristocrat" definition.

SPDR S&P Dividend ETF (SDY)

SDY tracks the S&P High Yield Dividend Aristocrats Index. It goes after S&P Composite 1500 Index constituents that have increased their dividends every year for at least 20 consecutive years.

As mentioned, it's yield-weighted, so names, including ExxonMobil, Chevron and AT&T (for now at least) receive higher weightings.

VIG vs. NOBL vs. SDY

Three different dividend growth ETFs. Three different methodologies.

One requires a 10-year dividend growth history, one 20 years and another 25 years. One is cap-weighted, one is equal-weighted and one is yield-weighted.

There are enough differences between the three that it has the potential of producing varying results depending on market conditions. Let's run the numbers on all three to try to determine the best of the bunch and see if that high yield strategy of SDY has paid off for investors.

Historical Returns

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The common inception date for these three funds would be NOBL's launch in late 2013, so I'll compare performance from that data going forward. It eliminates the financial crisis from the equation, but we do get the 2015-2016 high yield bond crisis and the 2020 COVID recession, so there are still a couple of drawdown events in there.

1-year performance is kind of interesting because the riskier high yield plus growth strategy outperformed. That's not terribly surprising because the economy has roared back and investors have rewarded growth and risk-seeking. The high yield narrative plays into that and SDY has led VIG and NOBL by 8% and 5%, respectively.

The longer-term picture isn't quite as favorable for SDY. During 2020, investors (at least initially) abandoned just about anything risky or having a high yield as the COVID recession deepened, but the lagging performance goes back even before that. Since late 2013, SDY has lagged the traditional dividend growth strategies by roughly 25%, so the high yield tilt hasn't paid off.

In terms of drawdowns, it's actually VIG that has seen deeper lows, although we're talking the difference between a 6% and 9% decline. It's also worth noting that VIG's expense ratio is lower than both SDY and NOBL by 0.29%, so that will definitely be a contributing factor as well.

Trading Liquidity & Flows

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All three of these ETFs are large enough that trading spreads are incredibly narrow across the board, so there's really no differentiation there.

From an investor perspective, the money is definitely migrating towards the core dividend growth strategies. VIG's inflow isn't surprising since it's been popular for years. The $4 billion 1-year inflow is consistent with the pattern of flows we've seen over the past several years. NOBL's inflows are lower on an absolute basis, but NOBL comes out far ahead on a relative basis. Traditional dividend growth has been the income strategy of choice for a while and continues to gain interest at the expense of quality and high yield. SDY has drawn virtually nothing over the past year even though it's outperformed.

Risk Metrics

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Risk-adjusted metrics look even worse for SDY. Dividend growth is generally considered a lower volatility strategy, but the growth plus yield strategy is actually about as risky as the broader market. The Sharpe ratio is lower. The information ratio is lower. Tracking error is higher. Beta is higher. Alpha is lower. Upside capture is lower. Downside capture is higher. Every ratio and metric is saying that SDY would have been the notably worse choice over the past 8 years.

Fundamental & Valuation Metrics

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The trailing P/E ratio is lower for SDY and is being confirmed by other ratios, such as P/S, P/CF and P/B. That's backwards-looking, of course, the forward-looking numbers tell the same story. According to the fund's website, SDY is trading at a forward P/E of 16 compared to a 21 multiple for the S&P 500. Dividend stocks, in general, are trading cheaper than the broader market, but the relative value at this point seems to be with those with a high yield tilt.

Fund Composition

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There are some significant differences between these three funds, even between VIG and NOBL, which only have the length of dividend growth history as a primary differentiator. VIG, which opens itself up to some of the more emerging dividend payers, has a MUCH higher weighting to the tech sector. If you want dividend growth but don't want to abandon your tech exposure altogether, VIG would be your choice.

SDY, not surprisingly, has a heavier tilt to the higher yielding sectors. The utilities sector is the big outlier, where SDY has a 14% weighting compared to 3-4% for VIG and NOBL. It also has overweights to financials (again, not surprising), real estate and energy. If you were to put labels on them, SDY probably rates as a slightly more cyclically-sensitive portfolio despite its heavy weighting in utilities, while VIG and NOBL as more traditionally defensive portfolios. This would essentially be confirmed by the riskier numbers we saw earlier.

Because it scours the S&P 1500 index instead of just the large-caps, SDY is the only one of the three ETFs that has a significant weighting to mid-caps. A full 1/3 of the portfolio's asset meet the mid-cap definition, so investors would be adding company size risk to their portfolios in adding SDY along with cyclical risk.

Conclusion

Over the past several years, the decision to go with a high yield tilt within a dividend growth strategy has not paid off. Given the risk level assumed by investing in SDY compared to what we've seen from NOBL and VIG, you'd expect SDY to outperform. Instead, we've seen the opposite both on an absolute and risk-adjusted basis.

What we need for SDY is a cyclical economic recovery. From September 2020 through March 2021, when Treasury yields peaked, cyclicals were leading the market higher. During this time, SDY outperformed NOBL by 11% and VIG by 18%. We've seen SDY also outperforming over the past several trading days as energy and financials have rallied post-Fed meeting. If this Treasury yield spike can be sustained and we see the current energy supply crunch last for a while, that could be the formula that leads SDY back into a leadership position.

Market conditions seem to be improving for SDY, but keep an eye on the risk-adjusted metrics. They don't suggest a particularly attractive risk/reward tradeoff, but absolute return potential could make it worth it in the near-term.

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