Main Thesis

The purpose of this article is to evaluate the SPDR Portfolio S&P 500 High Dividend ETF (SPYD) as an investment option. I have recommended, and owned, SPYD in the past, but I gave up on the fund earlier this year. As I look to continue to diversify my portfolio, SPYD is back on my radar as it has trades at a marked discount to the broader market, and has a yield above 5%, which is uncommon for dividend funds. Despite these positive attributes, I am reluctant to pull the trigger again. The fund has under-performed my other dividend ETFs, and I see that continuing in the short term. SPYD’s dividend growth has been negative in 2020, which is a metric I do not take lightly. Further, the fund’s top sectors by weighting, Real Estate and Financials, both have headwinds due to the pandemic that are not going away any time soon.

Background

First, a little about SPYD. The fund is managed by State Street Global Advisors, and its stated objective is to “provide investment results that, before fees and expenses, correspond to the total return performance of the S&P 500 High Dividend Index”. SPYD currently trades at $27.07/share and yields 5.51% annually. My last review of the fund was in March, during the sell-off. At the time, I was disappointed with SPYD’s performance, as it was declining more than the broader market. Given that lack of defensive positioning, I divested my shares and replaced them with funds I believed would perform better. In hindsight, this was a good call. While SPYD has seen a gain in the interim, the broader market has more than doubled the fund’s return:

Source: Seeking Alpha

Given this lagging performance, I wanted to give this fund another look as we approach 2021, to see if I should change my outlook. After review, I do see some merits to owning the fund, such as its marked discount compared to the S&P 500, as well as the potential for its top sectors to rebound if the economy exceeds expectations. However, I also see multiple headwinds, such as the pandemic continuing to pressure areas like Financials and Real Estate, which make-up a substantial percentage of total assets. As a result, maintaining a neutral rating seems appropriate, and I will explain why in detail below.

Giving Up On SPYD Made Sense Over The Past 6 Months

To begin, I want to highlight the key reason I have been happy divesting SPYD in the short term, and that is performance. As my readers probably remember, I took some criticism for suggesting SPYD was not a great choice back in March. In fairness, the timing may have seemed a bit off, as selling anything at the height of a market correction may not be the wisest move. Of course, I did not sell SPYD and move to cash, but rather put that money to work in my other dividend funds, as well as my S&P 500 fund. Simply, I believed these options would perform better coming out of the correction, and hindsight has proved me correct (so far).

To illustrate, let us consider SPYD’s six month return against my two dividend ETF holdings and my S&P 500 fund, which are the iShares Core Dividend Growth ETF (DGRO), the SPDR S&P Dividend ETF (SDY), and the Vanguard S&P 500 ETF (VOO). The six month returns for each are shown below:

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Source: CNBC

Clearly, SPYD has under-performed, and by a noticeable margin. While its yield is higher, that does not make up for the total return disparity. Therefore, I feel pretty comfortable with my selections, and I’m happy to have moved out of that fund when I did.

Of course, I don’t want to harp on this point too much, because what matters now is future performance. With this in mind, I will use the next few paragraphs to explain why I feel it is unlikely SPYD will beat out these alternatives heading in to 2021.

Dividend Growth Has Turned Negative In 2020

An attribute I find particularly worrisome for SPYD has to do with its dividend. On the surface, SPYD looks attractive to me as a “dividend seeker”. With a yield over 5% in a low rate environment, that should pique my interest. However, I focus more on dividend growth than high yield, although having both is preferable. Unfortunately, SPYD lacks the growth aspect so far this year, which is not entirely surprising given all that has happened to the global economy. However, the decline in the distribution level from last year is quite concerning, as it sits around 18%, as shown below:

Jan – Sept Distributions 2019 Jan – Sept Distributions 2020 YOY Change
$1.25/share $1.03/share (18%)

Source: State Street

Now, in isolation this looks quite poor. But investors could certainly write this off as a Covid-19 development, and find the fund’s dividend appealing. While there is merit to this line of thinking, I would caution investors to consider how other dividends have held up so far this year. For comparison, if we look at the income stream from the three funds I mentioned above, we see they have not been impacted in the same way that SPYD has:

Fund YOY Dividend Growth
VOO (5%)
DGRO 9%
SDY 10%

Source: iShares; Vanguard; State Street

My takeaway here is this gives me a reason to remain neutral on SPYD. Yes, once the pandemic abates we should see dividends return to normal. And, in fairness, the broader market has seen negative growth this year, as measured by VOO’s distributions. However, two points stand out quite clearly. One, SPYD’s holdings have seen their distributions fall by a large amount. Two, the other funds, DGRO and SDY, have actually managed positive growth this year. Therefore, it is clear this pandemic is not impacting every sector or stock equally, and some are managing their cash better than others. The divergence is large, and has me feeling more confident in DGRO and SDY as a result.

Top Sectors Will Lag If Covid Pressures Do Not Abate

Another concern I have for SPYD going forward is the fund’s exposure to sectors that are feeling the pressure from Covid-19 more than most. While SPYD is certainly a well diversified fund, with no individual holding making up more than 1.55% of the total assets, it is still heavily concentrated in certain sectors. Specifically, the fund has almost 43% exposure to just two sectors – Financials and Real Estate, as shown below:

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Source: State Street

Starting with Financials, this is a sector I have a neutral view on as a whole, which I wrote about in detail last month. Simply, until the pressures from Covid-19 abate, this sector will have little chance of out-performing. The economic pressures of unemployment, upticks in fraud, low interest rates, and non-performing loans will all make this sector a speculative play. Of course, if we see economic surprises to the upside, or a vaccine come out sooner than expected, Financials are sure to rally. But these are not scenarios I expect to occur in the short term, which supports my neutral view.

To understand why, let us consider some underlying metrics that speak to the challenges of the banking sector. One metric that sends a mixed signal is announced job cuts. On the one hand, slimming payrolls and reducing headcount is a positive from an investor standpoint, as it can improve net profits. However, the size of the announcements are quite large, with planned cuts exceeding 2018 levels and are close to reaching what we saw last year:

Source: Bloomberg

I say this is a mixed point because a growing, confident sector is not one that sees historically high job losses. Yes, this could improve short term profitability, but it concerns me because it also sends the signal management is fundamentally planning for a difficult economic climate. Simply, the insiders know their companies are going to have tough times ahead, and they are planning for that eventuality. This makes the job cut announcements both a positive and a negative, in my view.

Another metric that is worrisome is the uptick in business fraud banks have seen. This stems largely from individuals and businesses attempting to take advantage of government stimulus programs. This is both disheartening from a human perspective, but similarly problematic for banks in that it could cause losses and/or waste resources for investigations and recovery efforts, etc.

And this is no small uptick. In fact, the number of monthly reported fraud cases rose quite substantially this summer, as shown below:

Source: Bloomberg

My takeaway here is the Financials sector has some serious challenges, which cloud my outlook for the remainder of the year. If Financials do continue to lag, this will weigh on the total return of SPYD, by extension.

Commercial Real Estate Has An Uncertain Future

In addition to my concerns regarding Financials, I also have a lukewarm view on the Real Estate sector. As investors are aware, this is an area hit very hard because of Covid-19, and I see these market forces punishing the sector for the foreseeable future. Even as states re-open, the value of retail, office, and other forms of commercial real estate are going to remain under pressure. Simply, the amount of time spent in malls, offices, hotels, and other properties is not going to return to pre-crisis levels any time soon. People are not going to feel as comfortable in public as they used to be for a while, and that reality will pressure in-store traffic, the return of workers to office space, and discretionary travel.

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The net effect is the Real Estate sector has a difficult road ahead. As an investor, it means buying in to the companies that own commercial space that may see fewer tenants, lower rents, and cash flow challenges. In the short term, the values of commercial properties are on the decline, which is a trend I do not see easing until some time next year:

Source: Real Capital Analytics

Ultimately, I would be very selective with Real Estate stocks at this time, focusing more on industrial and apartment REITs, rather than broad sector exposure. As a result, I view some of SPYD’s Real Estate exposure positively, while some of the stocks have significant headline risk. Therefore, this exposure is another reason for my cautious outlook.

There Is Still An Argument For Buying

Clearly, my tone is this article has not been very positive. However, I do want to emphasize that I am not bearish on this fund. The market has been holding up quite well despite the difficult macro-economic picture, and SPYD has plenty of upside potential the closer we get to a return to normalcy. While I see challenges for SPYD, value investors may find this fund particularly interesting. For those with a value perspective, SPYD could fit the bill because its buy-in price is below alternative dividend ETFs, and well below the broader S&P 500, as the chart below illustrates:

Fun/ Yield P/E
SPYD 5.51% 13
VOO 1.73% 28
DGRO 2.62% 17
SDY 2.96% 17

Source: State Street; iShares; Vanguard

It is apparent that SPYD is a relative value play right now. While this has been the case for a while, value could come back in to favor at any time. Therefore, for those predicting that rotation in to value, SPYD is certainly a way to play it. Coupling this relative value with an income stream that is more than three times what the S&P 500 offers, SPYD could certainly be considered a buy by many investors.

Bottom Line

SPYD has under-performed since my last review, which has been a consistent story in 2020. While the yield and P/E ratio offer an interesting value play, I am reluctant to buy back in to the fund at this time. The negative dividend growth is a concern, and the fund’s top sectors do not excite me. Therefore, I am maintaining my neutral rating on SPYD, and recommend investors consider any new positions selectively at this time.

Disclosure: I am/we are long DGRO, SDY, VOO. 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.



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