VYM Is Holding Its Own In A Difficult Year For Dividend Stocks

seekingalpha2023-11-28

Vanguard High Dividend Yield Index Fund ETF has performed well in mitigating downside risk compared to Schwab U.S. Dividend Equity ETF during a high-rate environment.Dividend stocks have not been as ...

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I am a shareholder of both ETFs, and I am impressed with how VYM has mitigated downside risk compared to SCHD during the high-rate environment. Dividend stocks haven't been as appealing as they once were when the risk-free rate of return was basically non-existent. Plowing cash into money market accounts, CDs, or treasuries to generate income wasn't an appealing option for many years, but as the Fed raised rates, these traditional investments became more lucrative. There are many reasons why people invest, and the objectives are often different. A segment of the investment community utilizes the equity markets to manufacture an additional stream of income, and VYM has been a compelling ETF to achieve this objective. Dividend stocks, in general, haven't had a banner year like big tech, as investors found less of a reason to take on equity risk when they could generate a larger yield from risk-free assets. Many income-focused ETFs have had a difficult year, but VYM has done a better job than most mitigating downside risk even though the markets have rallied thanks to the Magnificent Seven. While I had previously said I wouldn't exit my position in VYM but, I wouldn't be adding to it either, I am changing my mind and allocating more capital toward it before a Fed pivot is back on the table for me. Seeking Alpha Following up from my previous article on VYM In my previous article about VYM, which was published on 4/16/23 (can be read here) I discussed why I wouldn't consider adding additional capital toward the ETF. I also discussed what would need to occur for me to exit VYM and redeploy the capital toward other income investments. Rather than my investment premise continuing to deteriorate, I have become bullish again on VYM and wanted to write a follow-up article as my sentiment is starting to change. VYM has done a better job at managing a downturn in dividend stocks than many alternative equity-focused dividend ETFs There are many different income-focused ETFs these days. When I discuss VYM, I only compare it to equity-focused ETFs rather than ETFs that utilize an option overlay strategy to produce additional income. The ETFs that I normally compare VYM against are:  Schwab U.S Dividend Equity ETF (SCHD) iShares Core High Dividend ETF (HDV) iShares Select Dividend ETF (DVY) SPDR Portfolio S&P 500 High Dividend ETF (SPYD)  Seeking Alpha In 2023, dividend-focused stocks haven't faired well in a rising rate environment. Traditional equities that had previously been staples in the dividend community watched value erode as the Magnificent Seven pushed the market higher. Verizon (VZ) is up 10.57% in the past month but is still down -6.75% in 2023, and its yield still exceeds 7%. Other income standouts, such as Altria Group (MO) has fallen -8.9% in 2023, while Southern Company (SO) has declined by -3.18%, and Enbridge (ENB) has fallen -12.30%. Even names such as Johnson and Johnson (JNJ) and The Coca-Cola Company (KO) have fallen by 13.96% and 6.96%, respectively. The largest contributing factor toward income investments declining in value while the S&P 500 is up 19.23% in 2023 is arguably interest rates. The 2-year Treasury still has a yield of 4.95% and reached 5.49% earlier this fall, while the 10-year Treasury has a yield of 4.47%, and some were able to lock in yields as high as 5% just a few months ago. Some financial institutions are still offering a 1-year APY of 5.3% and 5.5% on CDs, while Fidelity is offering a 4.99% 7-day yield on money market accounts, and Schwab is offering a 5.25% 7-day yield on money market accounts. We don't live in a yield-starved environment, and anyone can find lucrative, risk-free investments to allocate capital toward rather than take on risk in the equity markets. The latest indicators show that a total of $5.73 trillion of assets is parked in money market accounts. As of 11/15/23, assets of retail money market funds increased by $10.52 billion to $2.23 trillion, while assets of institutional money market funds increased by $11.39 billion to $3.50 trillion. The allure from dividend stocks have faded, and investors looking for income continue to horde cash and take advantage of the high-rate environment. St. Louis Fed With so many dividend-focused companies in the red, VYM, and the other income-focused ETFs I compared it to have all endured declining share value in 2023. To my surprise, VYM is only down -1.86% compared to HDV, SCHD, DVY, and SPYD, being down between -4.63% and -9.55% for the year. VYM's portfolio has done a better job at withstanding a difficult macroeconomic environment than its peer group and has continued to deliver ongoing income to its shareholders. Why I am becoming bullish again on VYM My view on income investing has been that it is a separate portion of my portfolio that is dedicated to generating income without worrying about maximizing capital appreciation. This has been why I have favored SCHD over VYM for so long. SCHD had typically provided a larger yield while generating more capital appreciation than VYM. Of the peer group I listed, I am a shareholder of VYM, SCHD, and SPYD. On several occasions, I had considered either reducing or exiting my positions in VYM and SPYD and redistributing the capital toward SCHD. I am glad that I didn't exit VYM as it went back to my decisions about building a diversified portfolio to mitigate risk. I am not sure that anyone expected the Fed to push rates as high as they did, but we got to see the effects on the market in a high-rate environment. I am planning on adding fresh capital and adjusting some of my positions going into 2023. VYM is no longer on my list of ETFs I will be scaling down, rather, I will probably be adding to the position as it has shown how well it can navigate difficult environments and outperform its peers when income investments fall out of favor. I believe that a significant amount of capital will flow into the markets over the next 6 months as the Fed is at the end of its tightening cycle. Institutions have $3.5 trillion parked in money market accounts, and at some point, they will need to deploy this capital. As rates decline, institutions will have less of a reason to stay in cash and will either look to recreate this yield or put the capital to work in other assets. Individuals will also face the same dilemma. While there are some individuals who just want to have cash on hand, there are others who use risk-free assets as a proxy for equities to generate income and will look to recreate the income they were accustomed to getting. The CME Group Fed Watch Tool indicates that rates have the highest probability of finishing 2024, with a target rate of 450 - 475 bps. When I look at the Fed Dot Plot, there is a significant chance that rates will have a 3 handle on them sometime in 2025, and rates could be under 3% in 2026. St. Louis Fed St. Louis Fed The Fed has been unpredictable, but all of the data is showing that we're much closer to the end of their tightening cycle than the beginning. As rates start to decline, institutions and individuals looking for income will look to deploy capital back into the equity market from money market accounts and when CD or bond ladders start to mature. I believe that dividend stocks with modest yields and track records of dividend growth will come back into favor, and capital will gravitate toward them. VYM provides investors with a basket of individual equities to generate yields that outpace traditional index or total market funds through a passively managed fund. VYM employs an indexing investment approach designed to track the performance of the FTSE High Dividend Yield Index, which consists of common stocks of companies that pay dividends that generally are higher than average. I think investors will look to deploy capital toward both individual equities and ETFs that can help recreate a stream of growing dividend income, and both scenarios would be good for VYM. Over the years, VYM has provided its investors with 12 years of dividend growth at an average growth rate of 5.6%. VYM currently has a dividend yield of 3.16%, which is manufactured from the 455 positions within its portfolio. The level of diversification that VYM has created helps mitigate downside risk in 2023 while allowing the dividend to grow. I think a lot of investors are going to look for income investments that have the ability to protect their downside, and this could put VYM ahead of its peers. The other aspect that people will look for is dividend growth. While risk-free investments could produce a larger yield than VYM for another year or so, their yield will be continuously decreasing while VYM grows its dividend. VYM could find itself in a situation where its yield remains stagnant or even declines if its share value increases, but more income will be generated through the annual dividend growth. Investors are going to look toward yield on cost rather than what the current yield is. Shares of VYM are $106.01 and pay a dividend of $3.35. Hypothetically, if shares go to $130 in the next 3 years and the dividend grows at the same 5.6% rate annually, VYM would pay a dividend of $3.95, which would yield 3.03%. While VYM would be yielding 3.03%, which is less than the yield today, the dividend would have grown by 17.76% over the 3-year period while risk-free assets watched the amount of income they generated decline. Shares of VYM purchased at $106.01 would have had a yield on cost of 3.72% rather than 3.03%. I think these are the scenarios that institutions and individual investors looking to generate yield will be looking for. Seeking Alpha Conclusion  I have upgraded my investment thesis on VYM as I am once again bullish on this dividend-focused ETF. While I had leaned toward SCHD in the past because of the higher yield and additional appreciation, VYM has done a better job at mitigating downside risk during a tough macroeconomic environment where rates continue to rise. The Fed is projected to pivot sometime in 2024, and I think it will occur before summer. I think that dividend stocks with track records of modest growth will return to favor as institutions and individuals look to recreate the income generated from risk-free assets. VYM could be a huge winner as its portfolio has demonstrated it can mitigate risk while growing its dividend. As I look to reposition some of my portfolio for 2024, I will be looking to add to VYM rather than decrease my exposure.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":1,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2386143613"}