Years ago, before the financial crisis and quantitative sparked a wholesale re-writing of the ground rules, investors viewed dividend yields as afterthoughts, something that was nice to have but not a critical component. This did not always make sense - study after study has shown that over very long time periods, dividends account for the lion’s share of portfolio performance—but in prior eras boasting bond yields three or four times higher than today’s payouts, investors were more interested in stocks for capital appreciation.
Accordingly, dividends did not have the same cachet as they do in today’s Zero Interest Rate Policy world, and companies were less likely to alter their dividend policies from year to year. In fact, a theory sprang up in the early 1990s that essentially encouraged investors to buy the ten highest-yielding stocks in the Dow Jones Industrial Average on the last trading day of each calendar year. Under this theory, these “dogs” of the Dow were oversold.
The logic is that companies do not generally alter their dividend policies in response to normal fluctuations in the business cycle. An above-average yield, therefore, suggests a company near the end of a downturn. In turn, market forces should act to bring its dividend yield back into line with its peers. All else being equal (especially the dividend), this means a rise in price. Although beset with a lot of holes, the so-called “Dogs of the Dow” theory holds water; it has outperformed the S&P 500 over 1, 3, 5, 10 and 20-year time periods, and due to a furious pace of dividend increases in 2013, even trumped the broader market by a few percentage points last year.
Unsurprisingly, there is an ETF that replicates and expands on this theory. The ALPS Sector Dividend Dogs ETF (SDOG) takes the five highest yielding stocks in each of the ten S&P 500 sectors and simply weights them equally across its $469 million portfolio. Accordingly, no stock makes up more than 2.4 percent of the total, and positions are rebalanced quarterly. Sector diversification is provided as well, with roughly ten percent of assets allocated fairly equally across each of the ten sectors. Industrials, at 10.9 percent, have the largest share, while Energy makes up 9.3 percent. The largest positions at the end of 2013 were Pitney Bowes, Safeway, Seagate Technology and Bristol-Myers Squibb. 22 percent of assets are concentrated in the fund’s top ten positions.
Note that this is a blue-chip ETF with mostly blue-chip stocks. Nearly 60 percent of fund qualifies as either giant- or large-cap, with the remainder in medium-cap and no exposure to small-caps. Meanwhile, the ETF’s indicated annual yield comes in at 3.58 percent, in line with the other large-cap dividend value ETFs on our list.
The collapse of interest rates has driven yield-hungry investors to chase yield wherever they can find it. This approach, however, can lead to overconcentration. By expanding the Dogs of the Dow strategy to each S&P sector, SDOG delivers both above-average yield and broad portfolio diversification. Built on one of the simplest and most successful stock market strategies around, we suggest income-oriented investors buy SDOG.
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ALPS Sector Dividend Dogs ETF (SDOG) is a component of the D2 Capital Management Multi-Asset Income Portfolio. Disclosure: I own the D2 Capital Management Multi-Asset Income Portfolio
The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville. The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.
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