This September, I have already published a few articles on dividend-focused exchange-traded funds. I believe the topic will likely not lose relevance in the medium term, as the great dividend reset amid the pandemic-induced economic doldrums coupled with depressed bond yields are not going to evaporate in a second, thus I hope my work will be of use for those investors who are struggling to find apt dividend picks.
Today I continue my series of articles with a note on Invesco High Yield Equity Dividend Achievers ETF (PEY).
In my opinion, the fund has one essential advantage: it is composed of stocks with appealing yields and at least ten years of consistent dividend growth (and even a few dividend aristocrats), which, upon cursory inspection, somewhat instills confidence that they are efficient and resilient enough to continue increasing the payout at least in the near future. However, PEY also bears some disadvantages that a scrupulous investor should take into account.
The top line
With ~$638.9 million in assets under management and a 5.16% twelve-month distribution rate, PEY tracks the NASDAQ US Dividend Achievers 50 Index (DAY). The index itself represents a fraction of the NASDAQ US Broad Dividend Achievers Index (DAA). DAA, in turn, is based on the NASDAQ US Benchmark Index (NQUSB) (page 2).
DAY is an index with a dividend yield weighted methodology that encompasses no more than 50 stocks. As comes from its name – dividend achievers – the essential eligibility criterion is a company’s dividend growth story. As stated in the DAA methodology, to be included in the index, a company must increase its annual regular payout for no less than a decade.
During the evaluation in March every year, managers take into account trailing-twelve-months dividend yields of stocks as of the last trading day in February (page 2), not estimated future payouts. The higher the yield, the better. It is worth noting that the pace of DPS growth or efficiency metrics do not influence the weight of a stock in the index.
Importantly, only 12 securities from one sector are allowed. This rule helps to maintain a certain level of diversification. For example, the fund has precisely 12 stocks from the financial sector, which, in turn, has a ~24.8% total weight, precisely in-line with the rule that one sector can account for only 25%. The methodology also clarifies that a single stock can have a weight of 4% or less (page 3). Anyway, I would not say that PEY is exemplary versatile and thus have an ideal risk profile, which I will discuss a bit later.
There is also a specific market-cap criterion: a market value of a company’s equity must be equal or above $1 billion. A crucial remark is that DAY does not include REITs or LPs, which, in many cases, have meaningful yields. That is one of its principal differences from the NASDAQ International Dividend Achievers Index (DAT), an index I have touched upon in my recent article on Invesco International Dividend Achievers ETF (PID).
What a 10-year DPS growth story might tell about a company? On the one hand, to increase DPS for a decade, a firm must have a carefully calibrated capital allocation strategy, so it can balance capex (both maintenance and growth), working capital, and operating cash flow to deliver sustainable FCF (or at least opt for reasonable financing options, when the perfect balance is not achievable, given whatever reason, from plummeted commodity prices to hefty capex to bolster expansion). On the other hand, a decade is a period not long enough to prove a company is fully recession-resistant and can agilely adapt even to a pronouncedly depressed macro environment and, what is principally important, to increase the payout despite sales decline. For example, Eastman Chemical (EMN), a diversified chemicals industry heavyweight with a ~1.58% weight in the fund, shored up by the buoyant economic growth after the Great Recession, increased the DPS in Q4 2010 and has been improving the payout since then. But this year, I reckon the prospects of the dividend hike are clouded.
Anyway, it does not mean PEY only encompasses shares of companies with a relatively short dividend growth story. 12 of the total 50 holdings (almost a quarter; in total, their weight equals 22.9%) are dividend aristocrats, which means they have been consistently increasing the DPS for at least 25 consecutive years. For example, PEY holds common stock of prominent supermajors Exxon Mobil (XOM) and Chevron (CVX), which, despite a slew of dividend reductions in the shattered petroleum industry (their closest peer, another supermajor Royal Dutch Shell (RDS.A) that had been paying the dividend for decades slimmed down the DPS in April and shocked energy investors), are holding the line on shareholder rewards. Certainly, without massive debt proceeds (thanks to rock-bottom rates, XOM borrowed $9.5 billion in April) and thorough opex and capex cuts that fortified the liquidity, their DPS growth story would be inevitably reset.
But again, dividend payments are not set in stone. Even though more than a quarter of a century of systematic DPS hikes is impressive, it does not guarantee that a company will generously reward shareowners ad infinitum.
Diversification. Solid footprint in recession-immune sectors, but poor exposure to growth names
I would not say that the fund is perfectly diversified, as the top ten stocks have a combined weight of ~29.59%. The next issue not to be ignored is that PEY has material exposure to the embattled financial sector (as I said above, it has a ~24.8% weight), which is clearly a drag on its performance. The woes of the sector have been mounting since 2019 when the Fed embarked on a path of dovish measures, which put pressure on banks’ profit margins, as they simply cannot slim down deposit rates ad infinitum and go lower than zero. This year, the pandemic has exacerbated the situation. The sector heavyweights are scaling down their net lending revenue and net interest income forecasts because a V-shape reversal in interest rates in the short term is impossible.
Moreover, PEY invested in OKE, XOM, and CVX, three energy names (~9.3% weight in total) that were hammered by the devastating oil price decline and have not recovered yet, as their 1-year total returns are deeply sub-zero. At the same time, the only IT company in the portfolio is International Business Machine (IBM) with a ~2.03% weight.
The silver lining is that PEY also has meaningful exposure to defensive names in the non-cyclical sectors like utilities (~20.7% weight) and consumer staples (~15% weight), which, combined, account for ~35.7% of the overall holdings.
How PEY’s total return compares to the S&P 500
Unfortunately, the S&P 500 easily trounced the fund with a 258.2% total return in the previous decade. As I said above, the main culprit is PEY’s overweight position in financials and underweight in technology.
It is also worth noting that the 10-year total return of Invesco International Dividend Achievers ETF (PID), a fund that is focused on non-U.S. dividend achievers, is even less appealing because of currency headwinds I discussed in the previous article.
PEY is a high-yield play with obvious advantages, like dividend-yield weighted methodology and exposure to almost recession-immune sectors.
But the issue is that it has an insignificant footprint in the tech sector, the high weight of financials in the portfolio, and a relatively high expense ratio (0.52% vs. an average ETF ER of 0.44%, as comes from the data provided by the WSJ) to boot.
Besides, the accommodative policy of the Fed made an ambivalent impact on PEY’s total returns. On the one hand, rock-bottom interest rates helped the energy titans to secure their dividend aristocrat status and staved off a more profound dividend reset, but on other hand, it hammered the financial sector and resulted in its underperformance vs. the tech-influenced S&P 500.
In sum, I am neutral.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.