High Dividend ETFs vs the S&P500

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Long-term investing in dividend paying stocks is an investing strategy adopted by many for generating a steady source of income through paid dividends. Alternative to acting as a direct source of income subject to capital gains tax (in view of the IRS, the paid dividends are income and taxed as capital gains), dividends can also be reinvested subject to lower taxes and potentially creating compounding effects with the appreciation of the stock.

Of course, these dividends are not guaranteed. As was seen over the past 3 years, multiple companies and REITs either significantly reduce their dividends, or paused them all together. Take AT&T for example, which after over 20 years, cut its dividends by nearly 50% in early 2022. This loss was further compounded by the stock itself declining by roughly 50% since the 2020 market crash.

Despite these risks, long-term investing in dividend stocks is still viewed as an attractive investing strategy. For illustrative purposes, let's consider AT&T (T) and IBM (IBM), two companies in different sectors that have been publicly traded for over 30 years and historically have paid out a generous dividend yield. For reference, the forward dividend yield of IBM and AT&T currently stand at roughly 4.5% and 7.2%, respectively. The compounded annual growth rate (CAGR) of a one-time investment over 5 years in each of these two companies relative (difference) to the S&P500 tracking exchange-traded funds (ETF), SPY, is shown in the figures below. Both investment strategies outperformed SPY following the 2000 dotcom crash, though have underperformed it since the recovery from the 2008 great financial crisis. The mean of the total return of these investments, relative to the S&P500, of this strategy at any point in time for IBM and AT&T was -4.5%, and -0.6%, respectively. In other words, even with reinvestment of dividends, S&P500 on average would have out performed over a 5 year period.

The type of return of the investment in the AT&T example mentioned above is not an outlier. Historically, it has been atypical for an individual stock to outperform the broader market in the long term.

As an alternative to buying individual dividend paying stocks, there are numerous ETFs existing with the goal of generating higher yields by investing in various types of financial instruments, with defined selection criteria and re-balancing rules. This raises an interesting question: how have high-yield ETFs, which are managed by someone else and provide auto-balancing, compared to the S&P500 for generating passive income?

With focus being on generating guaranteed yield and income, equities that enable that objsective tend to be concentrated in certain sectors. Inspection of over 8600 individual stocks reveals that (as one may expect) high dividend paying stocks tend to be concentrated in energy, utility and real estates sectors (see figure below). Naturally, as will be seen in the following section, this generally translates to higher yielding ETFs as having a higher level of concentration in energy, utility, and real-estate sectors, with little exposure to growth stocks.

With the dominance of growth stocks over value stocks over the past decade, naturally one may expect these high-yield ETFs to have underperformed relative to the Nasdaq during period of rapid growth. So instead one wish to compare them them to broader US market, namely the S&P500, by back-testing a fixed-time and one-time investment in various funds.

ETF Selection and Comparison

To select which ETFs to consider, we begin by inspecting a list of ETFs and sorting them by their current annual yield in descending order. Then some of the top ETFs (sorted by their annual yield) are picked whose first inception was at least Jaunary of 2014, while at the same time looking for some diversity of the selection (i.e. there are other higher yielding ETFs that may not have been considered here). Setting the cut-off inception date to January of 2014 (nearly 10 years) is not long enough cover the 2008 recession, but it is long enough to include the major market crash observed in 2020.

Table below lists the selected ETFs for this article, sorted in descending order by their (current) advertised annual yields.

Ticker	Dividend (%)	Expense Ratio (%)	Inception
PDBC	13.04	0.59	2014-11-07
MORT	12.85	0.41	2011-08-16
SDIV	12.67	0.58	2011-06-08
FTGC	11.80	0.95	2013-10-21
BIZD	10.70	11.17	2013-02-11
QYLD	8.59	0.60	2013-12-11
XYLD	8.35	0.60	2013-06-21
EWZ	9.02	0.58	2000-07-10
DIV	6.33	0.45	2013-03-11
EWT	4.44	0.58	2000-06-20

The ETFs in the list are diverse enough to include REIT related funds, US funds, international funds, and funds with commodity-linked financial instruments.

For each fund, we look at the 5-year compounded annual growth rate with dividend reinvestments of a one-time investment at various points since the inception of the fund. This value is compared to the same investment in S&P500 tracking fund, SPY. Here's what we mean by that, and how to interpret the graphs that will follow

1. Assume a one-time investment at a given point in time, T₀, is made in the given ETF
2. Compute the CAGR, R₀, using the total return including reinvestment of dividends after 5 years following T₀
3. Report the difference of R₀ against the same investment in SPY.

That is, (T₀, R₀) represents a single point on the time-series which is the 5-year CAGR of an investment at T₀ and realized at T₀+5 years. This process is repeated for various points in time. The last available point on the time axis of the time-series will therefore be 5 years before present time and represents the current CAGR of an investment made 5 years ago. To be exact, the CAGR is compared against with CAGR of an equivalent investment in S&P500. That is, a positive "relative" CAGR means outperforming the S&P500, while the negative one means underperforming it by the specified input.

This means that the latest point in each graph will be dated back to 2019, with it representing the current value of the investment that started in 2019.

PDBC

PDBC is an rule-based and actively managed fund with the goal to "provide long-term capital appreciation using an investment strategy designed to exceed the performance of DBIQ Optimum Yield Diversified Commodity Index Excess Return" by investing in "Commodity-linked futures and other financial instruments" on 14 of the world's most heavily traded commodities. The current breakdown of the composition of PDBC (see figure below) is such that close to half of the fund is composed of commodities directly linked to oil and gas, while roughly 25% is food commodities.

The return of the fund in 2022, during the same time where we experienced a 40-year record inflation rate may be unexpected. Excluding paid yield, the fund had roughly a -1.5% negative return in 2022. Looking at the peak to trough from 2020, where oil futures hit negative values, to 2021, the fund had a 100% appreciation.

The inception of the PDBC fund took place in late 2014, or few months after the period where the price of crude oil dropped by over 70%. Figure below compares the relative performance of a one-time investment to S&P500 at various points since the fund's inception. To better understand how to interpret the figure, see notes in the preceding section.

This 5-year investment period of a one-time investment including dividend reinvestment would have underperformed S&P500 besides a brief period in 2017. It's worth mentioning that the latest point in the graph, namely 2017-09 represents present CAGR of the fund relative to S&P500. While commodities including oil had a significant rally in 2022, the considered 5-year investment period fails to capitalize on it.

The time-history of the investment performance in PDBC may not paint the full picture since its inception occurred following the recovery from the Great Financial Crisis (GFC) and a cycle where growth stocks were dominating. For reference, the graph below compares the CAGR, excluding yields, between Crude Oil and SPY since the year 2000. Up to the start of the GFC, a 5-year investment in crude oil would have outperformed the S&P500.

FTGC

FTGC is an actively managed ETF with strong correlation to PDBC providing exposure to 10 to 35 commodity futures or commodity-linked financial instruments. The fund describes the objective of FTGC as seeking "total return and a relatively stable risk profile while providing investors with commodity exposure".

Bonds and equities have historically had no and negative correlation to inflation rates. Commodities on the other hand have historically shown a better correlation to inflation since the relative price of commodities increases with the decreasing purchasing power of currency. The correlation of the FTGC fund with the year-on-year (YoY) inflation rate obtained from the consumer price index (CPI) is visually noticeable since the inception of the fund. This correlation is most pronounced with not inflation itself, but rather the rate of inflation, or more specifically the YoY inflation rate. After the 2020 market crash which was followed by a 40-year record inflation rates, the fund nominally appreciated in nominal value by over +100% relative to its low, and has since dropped (along with inflation rate) by roughly -25% from its peak.

The current largest single commodity exposure of FTGC is soybean future contracts making up 21% of the fund, compared to PDBC's current exposure standing at 6%. Energy-related commodities currently make up roughly another 30% of the fund.

Looking at the performance of a one-time 5-year investment in the fund at any point in time with dividend reinvestments since the inception of the fund, two characteristics are immediately noticeable:

1. The relative performance against the S&P500 follows the same behavior as PDBC
2. This strategy would have have consistently underperformed the S&P500.

At its lowest, the under-performance of the fund would have been as much as -25%. This again my not be painting the full picture and is not an indicative of future performance since the fund inception only dates back to late 2013 in a low inflation-rate and low interest-rate cycle where growth stocks were dominating.

SDIV

The inception of SDIV dates back to 2011, with the fund tracking the Solactive Global SuperDividend Index, and invests in 100 global high-dividend paying equities across the world with quarterly re-balancing. The yield of SDIV currently stands at roughly 12.7%.

Requirements for stocks to be included in the SDIV fund include:

• Dividends greater than 6% and less than 20%, with a minimum of 3% dividend for the stock to remain in the index
• 1M average trading volume over 3 months
• Evidence of "stable" dividend yields in the future

As expected, due to the high dividend requirements, financial, material, and energy sectors make up the majority of the index.

US equities currently make up the majority of the composition of the ETF totaling to roughly 33% of the fund. Brazil, Australia, and Hong Kong are the following top 3 weighted countries in the fund.

Given the exposure to Australian and Hong Kong markets, for reference it's worth looking at performance of the Australian S&P/ASX and the Hong King HSI index against the S&P500 for the past 30 years. In the graphs below, each dot represents the annual return of the indices plotted against each other. The diagonal line represents a 1:1 performance of the two indices. Any point falling above the line represents out-performance of the US broader market. Any point falling in the fourth quadrant represents the worst case scenario, which is the S&P500 had positive returns, and the other index had negative return and hence exasperating losses in terms of opportunity costs.

The Australian S&P/ASX generally outperformed the S&P500 in the early and mid 2000s, and only had 3 years where it had a negative return while S&P500 had a positive return. At the same time, for 13 years the market had a lower return the S&P500, and only 7 years where it outperformed the S&P500. Hong Kong's HSI has been more volatile, with 5 years significantly underperforming the S&P500.

Let's get back to SDIV. Since the beginning of the year, the SDIV fund price is up by merely +1%. The ETF has not recovered to its previous time since the 2020 crash, and currently is roughly -10% lower its lows in 2020. The total return (relative to S&P500) of a one-time 5-year investment in the fund since its inception at any point in time would have consistently underperformed the S&P500 with an average relative loss of -13%.

DIV

DIV is offered by the same ETF provider as SDIV, namely Global X. The inception of the DIV inception came 2 years later than SDIV in 2013, with the fund tracking INDXX SUPERDIVIDEND© U.S. LOW VOLATILITY INDEX, investing in 50 of the highest dividend paying equities limited to only the United States. The yield of DIV fund currently stands roughly at half of SDIV at around 6.3%.

Requirements for stocks to be included in the DIV fund include:

• Beta value lower than 0.85 of the local country benchmark
• Minimum 500M market cap
• 12-month dividend above 1% and less than 20%
• Evidence of "stable" dividend yields over the past 2 years
• Current dividend yield is greater than or equal to 50% of the dividend yield from the previous year

Energy is currently the highest weighted sector standing at over 20%. Unlike the SDIV fund which has exposure to non-US equities, the consumer staples and financials together make up the second largest weighted component of the index with a combined weight of 26%.

Since the beginning of the year, the SDIV fund price is down by roughly -7%. The ETF has bounced by roughly 45% since its 2020 low. The total return (relative to S&P500) of a one-time 5-year investment in the fund since its inception at any point in time would have consistently underperformed the S&P500 with an average relative loss of -11%.

BIZD

BIZD aims to track the overall performance of publicly traded business development companies (BDCs) in the US. BCDs are specialty finance companies which primarily make investments in small- and mid-sized companies and financially troubled businesses. As traditional lending may be limited or unavailable to these companies which may be unrated or rated below investment grade and come with higher risk than well-established publicly traded companies, the demand for BCDs lending increases allowing for loans with a relatively higher interest rates. Additionally, BCDs must distribute at least 90% of their taxable income in order to be tax-except from corporate level taxes. This translates to investors receiving higher than normal yields, with exposure to private equity- or venture capital-like investments.

The BIZD fund has a current yield of roughly 10%, and a whopping expense ratio of over 11% most of which is attributed to expenses charged by the underlying funds. The fund's performance year-to-date, excluding dividends, is roughly +18% which may be attributed to the current high interest rate environment.

A one-time 5-year investment in BIZD fund with dividend reinvestments would have only briefly outperformed the S&P500 in early 2018. For any other time, it would have had negative return relative to the S&P500, with an average relative loss of -6.5%.

QYLD and XYLD

QYLD and XYLD track the BXNT and BXM indices and aim to generate income through covered call writing in the Nasdaq100 and S&P500, respectively. Covered call writing has historically produce higher yields in periods of volatility. Since these funds track the Nasdaq100 and the S&P500, they have the same underlying companies as the S&P500 and Nasdaq100. The funds both have a current yield of over 8%.

Despite their higher annual yields as well as containing the same equities in S&P500 and the Nasdaq, both of these funds have underperformed the S&P500 when investing over a 5-year period. Since their inception, a one-time 5-year investment in any of these funds, on average would have returned between -5% and -9% relative to the same investment in the S&P500.

EWZ

The EWZ fund provides exposure to mid- and large-sized companies in Brazil. After the US and Canada, Brazil currently stands as the third largest economy in the Americas, with a GDP of $1.9 trillion. Despite the deep recession that the Brazil experienced in 2016, investors are once again becoming optimist in the future prospect of the country's growth.

Figure below shows the performance of EWZ relative to the S&P500 for the past 30 years. In the early 2000s, the fund significantly outperformed the S&P500 for multiple years, with an out-performance of as much as 100%.

The MSCI Brazil Index itself trades at 1.3 book value (BV) and roughly price-earning (PE) ratio of 8 with a dividend yield of 7.3%. For comparison, the S&P500 currently trades at roughly 20 times PE ratio, 4.2 PB, and a dividend yield of 1.5%.

Financials, energy, and materials sectors together make up roughly 65% of the index, with Vale and Petrobras alone making up roughly 30% of the fund. The fund currently has an attractive 9% annual yield, and it is up +12% year-to-date. A 5-year overview of the fund is not as attractive, with the fund effectively being flat excluding dividends.

Looking at a 5-year one-time investment with dividend reinvestments, the EWZ fund significantly outperformed S&P500 in the early 2000s following the dotcom bubble. A 5-year investment anytime between 2000 to 2006 would have had a +20% return relative to S&P500. Its performance following the 2008 Great Financial Crisis of 2008 however had an opposite mirror of the performance in the early 2000s, with the fund on average returning -20% relative to the S&P500.

EWT

The EWT fund provides access to the Taiwanese stock market by holding mid-sized companies in Taiwan. The fund is heavily weighted in the information technology (IT) sector, where the Taiwan Semiconductor Company (TSM) alone currently makes up more than 22% of the fund. The of news of Warren Buffet's Berkshire Hathaway exiting their positions after holding it for only one quarter quickly spread highlighting the current uncertainty and geopolitical tensions.

Unlike most of the earlier visited funds, the performance of a one-time 5-year dividend reinvestment in EWT has been cyclical. With the exclusion of 2002 and 2004, this investment generally outperformed the S&P500 by up to 7% in the early 2000s. Following the GFC and its recovery, the same investment underperformed the S&P500 by up to 14%.

Compilation

For comparison, the following graph compares time-history of the same investment, namely a one-time 5-year with dividend reinvestment, in each of the above funds. EWT and EWZ whose inception dates back to early 2000s both outperformed the S&P500 in the early 2000s. Since the mid 2010s where most of the other funds inception took place and coincided with the low-interest environment where growth stocks were booming, the same investment (including dividends) mostly underperformed the S&P500.

Table below summarizes the maximum CAGR of a one-time investment in each of the fund for a duration of 5 years with dividend reinvestment, relative to the same investment made in the S&P500. The EWZ fund had a +60% difference in early 2000.

It would be unfair to compare the mean of each fund's return relative to the S&P500 since each fund's inception is different. Instead, the table below also summarizes the mean and maximum CAGR of each fun for a one-time 5-year investment with dividend reinvestment since January 2014.

Ticker	Dividend (%)	MAx CAGR (Ticker - SPY) since inception	Mean CAGR (Ticker - SPY) since 2014
PDBC	13.04	+5.8	-8.9
MORT	12.85	-0.1	-10.5
SDIV	12.67	-6.0	-16.5
FTGC	11.80	+0.2	-13.1
BIZD	10.70	+0.6	-6.0
QYLD	8.59	+0.3	-5.1
XYLD	8.35	-5.0	-9.6
EWZ	9.02	+60.2	-10.0
DIV	6.33	-4.5	-11.8
EWT	4.44	+8.7	-1.0