A couple of months in the past, I reviewed the WisdomTree U.S. Excessive Dividend Fund ETF (NYSEARCA:DHS) with the conclusion that the DHS ETF was outperforming on the time resulting from its elevated vitality exposures. I warned:
DHS’s advanced index methodology produces these lopsided sector bets, which makes the DHS ETF both a ‘hero or a zero’ in any given yr, relying if its sector bets are in favour. For buyers who’re bullish on vitality, the DHS could also be near-term commerce. Nevertheless, I personally desire a extra constant methodology and efficiency in terms of dividend investing.
Sadly for DHS unitholders, since my article was printed, the DHS ETF’s efficiency has positively not been a ‘hero’, returning -10.3% in value and -8.5% in whole returns in comparison with the S&P 500, which returned +4.2% in the identical time-frame (Determine 1).
With roughly half a yr since my prior article, allow us to assessment why DHS has underperformed prior to now 6 months and what I see within the outlook for the long run.
Transient Fund Overview
First, allow us to undergo a short assessment of the DHS ETF’s technique, for many who aren’t conversant in the small print or can not perceive the ETF’s convoluted composition guidelines. The DHS ETF tracks the WisdomTree U.S. Excessive Dividend Index (“Index”).
From an preliminary universe of all U.S. corporations, the index first screens for corporations which have market cap larger than $200 million and each day buying and selling volumes larger than $200,000. ADRs, MLPs, BDCs, and royalty trusts are excluded from the index however frequent shares, REITs, and monitoring shares are included.
Subsequent, corporations are assigned a composite danger rating that weighs high quality elements like ROA, ROE, gross earnings, money flows, and momentum. Corporations that rank within the prime 5% by dividend yield and backside half by composite danger scores are additionally excluded from additional consideration.
Lastly, corporations are ranked by their annual dividend yields, with the highest 30% by indicated yield chosen for inclusion. The index weighing mechanism magnifies the impact of dividends to be paid within the coming yr because it weighs shares utilizing the proportionate share of every firm’s greenback dividend worth relative to the mixture anticipated money dividends of all index constituents.
Particular person firm weights are capped at 5%, and an additional sector weight cap of 25% (aside from Actual Property, which is capped at 5%) is utilized. Extra weights are rebalanced to different index members.
Dividend Focus Leads To Large Sector Bets
The DHS fund’s myopic deal with dividends results in giant sector bets. For instance, in my prior article, I famous that the fund had a 22.5% weight in Vitality, 20.4% weight in Healthcare, 16.8% weight in Shopper Staples, and 13.8% weight in Financials. Data Know-how and Shopper Discretionary shares had been nearly nonexistent within the portfolio (Determine 2).
When the fund’s sector bets are in favour, like in 2022, when Vitality was the highest performing sector, the DHS ETF ‘boomed’, returning 7.9% in whole returns in 2022, beating the S&P 500’s -18.1% by a rustic mile. (Determine 3).
The issue with this strategy is that no sector stays in favour perpetually. At the moment, the DHS ETF’s sector allocation continues to be closely weighted in the direction of Vitality (19.6%), Financials (17.0%) and Utilities (14.3%) (Determine 4).
Nevertheless, YTD, Vitality and Financials have been the most important sector laggards, returning -10.2% and -6.7% respectively as measured utilizing the Vitality Choose Sector SPDR ETF (XLE) and the Financials Choose Sector SPDR ETF (XLF) (Determine 5). Subsequently, DHS’s efficiency has been extra of a ‘bust’, returning -8.0% YTD to Might 12, 2023 in comparison with the S&P 500’s +8.0%.
Close to Time period Outlook Unfavourable
Trying ahead, given DHS’s heavy exposures to vitality and monetary corporations, my outlook for the DHS ETF is unfavourable. It is because because the U.S. economic system faces an impending recession, cyclical sectors comparable to vitality and financials are likely to underperform the market (Determine 6).
Vitality corporations are value takers; when an economic system enters a recession, there may be much less demand for vitality commodities, which causes vitality commodity costs to plummet (Determine 7). This considerably impacts vitality corporations’ revenues and earnings.
For monetary corporations, the issue lies with their enterprise mannequin, which depends totally on lending cash to corporations and people and incomes an curiosity unfold. Throughout recessions, corporations and people expertise monetary stress and default on their monetary obligations (that is modeled by elevated excessive yield credit score spreads in Determine 8 beneath). This creates elevated ranges of credit score losses for monetary corporations.
Subsequently, the DHS ETF, with heavy publicity to vitality and monetary corporations, is predicted to underperform the markets within the coming months because the U.S. enters a recession.
Up to date Peer Comparability
Determine 9 exhibits an up to date peer comparability chart, with the addition of extra funds below protection.
General, as now we have proven above, DHS’s close to time period returns have turned from peer main to look lagging, with long run returns nonetheless center of the pack.
DHS’s danger metrics are additionally uninspiring with volatilities and Sharp Ratios close to the center of the pack in comparison with friends.
Our evaluation of the DHS ETF stays the identical; the DHS fund is a ‘growth/bust’ fund that outperforms when the celebs (i.e. sectors) are aligned however underperforms when they don’t seem to be.
In my prior article, I warned that the DHS ETF’s excessive sector bets can result in ‘growth/bust’ returns. Sadly, we’re at the moment experiencing the bust section, as its heavy bets on vitality and monetary corporations aren’t properly suited to the present macro setting the place the U.S. economic system is headed in the direction of a recession.
For long-term buyers who don’t want to attempt to time the market, I like to recommend they steer clear of the DHS ETF and contemplate alternate options just like the Schwab U.S. Dividend Fairness ETF (SCHD) or the Vanguard Dividend Appreciation ETF (VIG), which have extra constant returns and extra balanced sector allocations.