Investors, still recovering from last year’s bear market, redirected over $60 billion into exchange-traded funds (ETFs) emphasizing dividends. However, after eleven months, this strategy has backfired as the largest dividend ETFs lag behind in a market driven by tech-focused fervor, with major proxies surging 15% or more.
At the bottom of the heap is the $18 billion iShares Select Dividend ETF (ticker DVY), witnessing a 5.4% decline on a total return basis. Despite betting on utilities and financial stocks, the dividends failed to deliver shelter in a tumultuous market.
This situation serves as a cautionary tale on the pitfalls of market timing. Investors sought companies with a history of profitable payouts as a precaution against the Federal Reserve’s most aggressive tightening cycle in 40 years. Unfortunately, these investors found themselves with underperforming companies, especially vulnerable as yields rose.
The casualties include the $20 billion SPDR S&P Dividend ETF (SDY), down 3% on a total-return basis, Schwab US Dividend ETF (SCHD), down 2.4%, and Vanguard’s High Dividend Yield ETF (VYM), which has remained mostly flat for the year. Even the funds with gains posted modest ones, such as Invesco Dividend Achievers ETF (PFM) up 6.6%, ProShares S&P 500 Dividend Aristocrats ETF (NOBL) up 2.3%, and Vanguard Dividend Appreciation ETF (VIG) up 9.6%, focusing on mid and large-cap stocks.
Invesco attributed PFM’s lagging performance to its underweighting of the “Magnificent Seven” and its overweighting of less “growthy” technology names like Oracle Corp., Cisco Systems Inc., and IBM Corp. ProShares highlighted the “fundamental performance” of NOBL’s companies, delivering earnings growth despite a shrinkage in overall S&P 500 earnings this year.
Dividend strategies, with a “value bias,” faced challenges in a “growth market” in 2023, according to State Street’s Matt Bartolini. Vanguard and BlackRock declined to comment.
D.J. Tierney, senior investment portfolio strategist at Schwab Asset Management, noted the challenging environment for dividend-paying, value securities in 2023, with a compelling case for fixed income in a higher rate environment.
While investors flooded into dividend strategies, they found themselves pushed into value stocks and away from Big Tech megacaps that fueled market gains. SDY, heavily concentrated in declining sectors like consumer staples, utilities, and health care, suffered. In contrast, VIG, with a notable allocation to information tech, stood out in a market dominated by growth stocks.
The notion that dividends enhance stock returns faces skepticism, particularly in a year where stocks valued for their cash flows struggled against rising bond yields. The inflow into dividend ETFs this year has been the smallest since 2006, with just $786 million, signaling a shift in investor preferences.
Despite the challenges, the ability to consistently pay dividends remains a hallmark of stability. The S&P 500 Dividend Aristocrats index, comprising S&P 500 members with 25 consecutive years of dividend increases, exemplifies the resilience of high-quality companies, outperforming most US active managers over the past decade.
However, some financial experts caution against a myopic focus on dividends. With bonds offering historically high interest rates, investors may find a more reliable income stream than dividend funds. Ultra-short bond ETFs have attracted significant capital, pulling in $30 billion this year after a record $42 billion in 2022.
