The recent sharp stock market sell-off is another reminder that many stocks continue to trade in overbought conditions. The valuations of growth stocks, particularly those in the tech sector, are still trading at dizzyingly high levels, but this month’s stock market volatility shows investors are becoming increasingly worried about the dangers ahead.

Yet, with the Fed likely to keep interest rates lower for longer, investors have few attractive places to park their cash and earn reasonable returns. Dividend stocks are one area that is seeing growing attention from financial commentators, especially since the yield spread between high dividend stocks and investment-grade corporate bonds has risen close to historic highs. Additionally, value investing, which has massively fallen out of favor for many years now, could be about to make a comeback as the performance gap between the least and most expensive stocks has only gotten wider since the pandemic.

With this in mind, the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD) could be about to break its multi-year cycle of chronic underperformance.

Portfolio construction

S&P Dow Jones Indices, the index provider, uses a multi-step method to select just 50 stocks to create the index which is tracked by the ETF.

Firstly, the top 75 highest-yielding stocks from the S&P 500 Index are selected, subject to there being less than 10 stocks coming from each GICS sector. If the highest-yielding 75 stocks include more than 10 stocks from the same sector, the next highest yielding stocks from other sectors are chosen instead to maintain 75 securities at this stage. As such, this prevents excessive sector concentration in traditionally high-yielding sectors, such as utilities and REITs.

Then, from the 75 securities, the top 50 with the lowest realized volatility, as defined as the standard deviation of the security’s daily price returns over the past 252 trading days, is chosen to form the S&P 500 Low Volatility High Dividend Index.

Volatility, as a second-step filter, therefore, plays a smaller role in determining the constituent holdings as it only eliminates a third of the securities that had already been screened by the dividend yield filter. By design, therefore, it can be quite possible that some of the chosen 50 securities for this index could have higher historical volatilities than the average S&P 500 constituent.

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Nevertheless, this volatility filter eliminates some of the very most volatile high-yielding stocks, which often include some of the biggest fallers over the past year. Low volatility is, therefore, a complementary factor, as it helps to exclude potential value traps which may only be showing high yields after having recently sold off sharply.

Yield-weighted index

It’s also important to note that the index is not market-cap weighted, but rather determines weightings of the constituent holdings by the dividend yield, with the highest yielding securities receiving the highest weights. Most likely, this skews the portfolio towards less expensive picks, which often are the same ones that offer higher yields.

At the time of reconstitution, the weight of each security is capped at between 0.05% and 3.00%, subject to the weight of each GICS Sector being capped at 25%. The index is rebalanced semi-annually, effective after the close of the last business day of January and July.

Past performance

ChartData by YCharts

The ETF’s performance in recent years may not be its best selling point, but that’s because it reflects the pro-momentum, pro-growth and anti-value rally that has been driving the stock market over the past few years.

SPHD also underperformed many other dividend-focused ETFs too, however, this is also reflective of the fund’s portfolio construction, which more heavily favors value picks. By comparison, the Vanguard Dividend Appreciation ETF (VIG) tracks an index which only invests in companies with at least ten consecutive years of increasing annual regular dividend payments, skewing it slightly towards the growth investment style, rather than value. The SPDR S&P Dividend ETF (SDY) similarly invests in stocks with a long track record of dividend growth but instead requires only companies that have increased dividends every year for at least 20 consecutive years.

The Vanguard High Dividend Yield ETF (VYM) tracks an index that is more in tune with SPHD, but it excludes REITs and is market-cap weighted. REITs have done particularly badly since the pandemic hit, but it is also a sector that seems especially well placed to benefit from the current low interest rate environment. This is because REITs are typically quite highly levered, so they stand to benefit more significantly from lower borrowing costs. Moreover, they are often seen as alternative investments to fixed income assets, making valuations particularly interest rate sensitive.

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Of course, past performance is not always a useful tool to predict future returns. It’s also important to remember that SPHD has not always been a laggard; in the three years between 2014 and 2016, the fund outperformed the S&P 500 by a cumulative 25.7 percentage points. Furthermore, it also outperformed the other three aforementioned dividend-focused ETFs by a cumulative minimum of 18.6 percentage points – that’s more than 6 percentage points annualized.

Invesco’s expense ratio for SPHD puts it somewhere in the middle of the pack in the domestic equity space – at 0.30%.

Low volatility?

One thing that was surprising was that the low volatility filter failed to protect SPHD’s portfolio against falling markets this year. This was because investors in the March sell-off did not flock to traditionally less volatile and defensive sectors, such as utilities and consumer staples, to the same extent as they usually do in other past market crashes.

ChartData by YCharts

Instead, as the pandemic was a one-off factor, investors flocked to safety in companies that seemed best placed to benefit from the impact of COVID-19. Perceived winners included e-commerce marketplaces, specific pharmaceutical firms, and companies that support remote working. For the most part, these were also stocks that have historically exhibited relatively more volatility than the market.

No market crashes are the same, and the most recent one being event-driven, saw investors act differently as they would have in the more frequently-occurring structural or cyclical bear markets.


ChartData by YCharts

Despite the index’s volatility filter, the fund’s current 1-year beta of 1.15 shows the fund is invested in a slightly greater proportion of cyclical stocks, or at the very least, some high-beta stocks represent a disproportionately large proportion of its holdings. A beta of more than one suggests that it has higher systematic, or market, risk than the overall stock market.

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As such, it isn’t really appropriate to consider SPHD as purely a defensive play; in fact, it is currently a slightly pro-cyclical play on high-yielding value stocks. This means that in spite of the ‘low volatility’ in the ETF’s name, there may be bouts when volatility may even be greater than the S&P 500 index, from which its investments are chosen.


Below is a table of the fund’s top 10 holdings:





CenturyLink Inc



Iron Mountain Inc



Dow Inc



Altria Group Inc



Vornado Realty Trust



Philip Morris International Inc



Huntington Bancshares Inc/OH



International Paper Co



PPL Corp



AT&T Inc


Source: Invesco

The Invesco website has a full list of its current holdings.

Bottom Line

With its focus on high yields, SPHD seems well positioned to benefit from the Fed’s current lower for longer interest rate environment. The ETF is a value, income and low volatility play – three investment styles that have fallen out of favor with the market recently. This may be about to change, however. The recent stock market correction has seen a rotation out of growth and momentum stocks which, should it continue, could see improving sentiment towards the kind of less expensive and higher-yielding stocks which SPHD is invested in.

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.