Dividend ETFs: Anomalies Are Great, So Long As They Aren’t Mirages

Expecting to find a “free lunch” in the market (returns potential that exceeds risk) has pejorative connotations, but in reality, anybody who doesn’t strictly adhere to the efficient market theory is, one way or another, trying to accomplish that very thing. In the income area, aggressive practitioners of this approach can expect to hear such phrases as “yield hog” or “sucker yield” and wind up guilty as charged as eye-catching yields turn phantom when dividends get slashed or omitted due to previously-discoverable but often overlooked company financial challenges. Yet with market interest rates still historically low and many investors and advisory clients needing income, the quest for yield can’t easily be abandoned. That adds pressure to turn over more rocks looking for potential traps.

© Can Stock Photo / alphaspirit

The Yield-Total Return Conundrum

The sucker-yield phenomenon, the inverse relationship between current yield and realized future return, is genuine. Fama-French documented it back in 1988, and I’ve seen it myself many times; Table 1 shows results of some examples. (Notice that even in the March 2020 crash, high yield did not serve as a protective shield against outsized losses.

Table 1

(Click on image to enlarge)

The silver lining in this is that the market itself is fairly adept at recognizing dividend-safety risk, something that is not always as recognizable in standard metrics, such as the payout ratio, as may suppose. This is especially crucial for assessment of income-oriented ETFs where stock-centric data can be challenging to obtain and “roll-up” to the level of the ETF. 

Assessment of Income-Oriented ETFs

The Chaikin ETF Ratings can be especially useful in evaluating Income-oriented ETFs. The model is based 60% on a three-pronged multi-horizon technical analysis model (which tilts toward the longer view) and 40% on portfolio-level “rollups” of the “quantamental” Chaikin Power Gauge ratings system which covers 20 fundamental, earnings-based, sentiment and technical factors, a suite that is likely to look more favorably on the sort of companies better positioned to preserve and/or grow their payouts. (Click here for a White Paper describing the ETF ratings in detail, or here for a Digest of that paper.)

The ETF ratings are bucketed five ways (Very Bullish, Bullish, Neutral, Bearish, Very Bearish) but given the extent of the market’s 2020 collapse, bullish ratings are hard to come by; almost all US equity ETFs are now rated Neutral or Bearish with the latter category especially well-filled as many otherwise favorably-rated ETFs were demoted out of that category by a market-sensitive safety-valve factor we include (a “technical overlay”). Our ETF-oriented PortfolioWise platform includes a finer level of information: For each ETF “group,” we sort by and present the Group Rank of each member based on our model’s underlying 0-100 score. 

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