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The Vanguard High Dividend Yield ETF (NYSEARCA:VYM) is a popular, income-oriented ETF that has provided shareholders an increasing stream of dividend distributions. We believe income-seeking investors should consider VYM as a core portfolio holding as the economic outlook continues to improve.
ETFs offer a simple, tax-efficient mechanism to access broad swaths of the market. ETFs have gained popularity on account of simple transactions, low fees, and market-linked performance. VYM is passively managed and tracks the performance of the FTSE High Dividend Yield Index, comprised of common stock with high current dividend yield. The index is comprised of high-yielding equities, excluding real estate investment trusts. The index is assembled through a quantitative approach, forecasting forward dividend yield. According to FTSE, forward estimated yield is calculated through I/B/E/S forecasted DPS values divided by share price.
Source: FTSE
VYM is simple and effective, offering investors an opportunity to diversify across over 400 individual high-quality equities. The fund offers a high dividend yield relative to traditional index funds such as the SPDR S&P 500 ETF (SPY), despite large portfolio overlaps. As it stands today, VYM’s current yield of 2.82% offers a meaningful spread over other income-producing assets. Despite a large compression in yield, VYM still outperforms the Vanguard Real Estate ETF (VNQ), iShares Core U.S. Agg Bond ETF (AGG), and other income-producing ETFs in terms of immediate dividend yield. As traditional stock/bond allocations break down due to low yields and rising interest rates, investors should seek alternatives to maintain a healthy portfolio yield. VYM’s combination of current yield and income growth provides a viable solution to combat inflation and replace the deficit in current yield left by traditional fixed income.
Let’s examine the fund and understand why VYM has been an all-star performer.
Portfolio
As mentioned above, VYM is a passively managed ETF linked to the FTSE High Dividend Yield index. The portfolio includes 412 holdings diversified across a variety of industries. The fund mandates that each holding pays a dividend, consistent with the overall objective of high income. To achieve high current yield, the fund focuses its allocation on sectors such as Financials (22.1%) and Consumer Staples (12.8%). The sector allocations uniquely position VYM to excel as investors face inflation and rising rates. The portfolio excludes a real estate allocation altogether, which may ease investors’ fears of rising interest rates. Should investors seek exposure to real assets, VNQ presents a viable complement.
Source: Vanguard
The portfolio has maintained a value-oriented focus, specifically towards large-cap equities. As a result, the fund’s constituents trade at an attractive valuation relative to broader equity indexes. As it stands today, the Vanguard S&P 500 ETF trades at an underlying price earnings ratio of 34.1x. In contrast, VYM trades at an underlying price earnings ratio of 18.4x.
Source: Multpl
While both valuations are rich in comparison to history, VYM still offers a more reasonable ratio. Furthermore, VYM is comprised of the most established companies as the median market capitalization remains near $150 billion. The fund’s top ten holdings include recognizable names with histories of robust performance and competitive advantages in their respective industries. Additionally, the fund is slightly less top-heavy compared to other index funds. VYM’s top ten assets account for 23.5% of total portfolio holdings as compared to the S&P 500’s 29.6% concentration.
Source: Vanguard
In summary, VYM offers a best-in-class portfolio of blue-chip equities. The dividend focus inherently orients the portfolio towards a value bias. As a result, shareholders have enjoyed growing distribution from top-performing firms across a variety of industries. As is consistent with other Vanguard funds, VYM commands an inexpensive management fee. The fund currently charges a 0.06% expense ratio, one of the cheapest on the market. In fact, Vanguard estimates that over the course of ten years, a $10,000 investment would incur a total of $142 in management fees.
Source: Vanguard
Performance & Distribution
We have established why VYM has gained popularity as a dividend ETF. The outcome of the strategy has been a powerful combination of income and capital appreciation over all time horizons. VYM has performed in line with the global equities market, slightly outperforming category averages over ten-year time frames. The fund has produced an annualized return of 13.08% over the past decade.
We want to highlight VYM’s strong performance in terms of total return. However, more importantly, the fund has produced stellar dividend growth, especially considering the appealing current yield of 3.00%. One should notice, the dividend yield has remained steady over the past ten years. Excluding times of stress (COVID-19), the yield has remained within 50 basis points of 3.00%. The fund’s distribution has grown at a rate close to the fund’s share price appreciation. Data reinforces this idea as VYM’s distribution has grown at a 10.29% annual growth rate since 2010. The double-digit annual growth in an already strong dividend is a powerful opportunity in today’s climate. Surprisingly, VYM was even able to raise its dividend in 2020 despite the impacts of COVID-19.
Strong Outlook
Income growth has become paramount in an inflationary environment. It appears inflation is more stubborn than initially anticipated as the current rate remains above 5.00%. The current rate remains higher than the past decade and individuals are feeling the impacts in everyday life. VYM’s ability to meaningfully grow its income is an important part of protecting purchasing power. Should inflation remain high, traditional fixed income investors will feel pain given their fixed cash flow streams.
Source: US Inflation Data
Although VYM’s ability to grow its dividend has been supported by the past ten years, past performance cannot predict the future. The economy must remain well aligned with VYM’s portfolio if investors hope the growth will continue. Recently, inflation and rising rates have not been the only risks plaguing investors’ minds. The global supply chain continues to feel the impact of COVID-19 and the stresses thereafter. The impacts remain substantial as container ships remain stationary off ports because of labor shortages. VYM’s continued success is dependent upon resolution of these issues.
We believe the future remains bright despite these challenges. The supply chain issues will subside given enough time and a normalization in the labor markets. Jamie Dimon, CEO of JPMorgan Chase (JPM), recently reinforced our thesis indicating he believes the issues will be completely resolved by next year. Furthermore, he painted a bright outlook based on strong consumer demand which has increased 20% since before the pandemic. VYM’s orientation towards consumer discretionary and consumer staples categories positions the portfolio to benefit as earnings grow from increased spending.
Additionally, VYM’s portfolio is diversified away from equities which pose substantial valuation risk. Domestic sectors such as reopening and stay-at-home stocks have performed well through COVID-19 for obvious reasons. However, their valuations have been driven to extreme levels, especially in the software and media categories. While investors have shown their appetite for risk, we do not believe valuations have much room to grow further, limiting upside in growth-oriented strategies.
Source: JP Morgan
Downsides
We believe VYM is a core holding that investors should consider for a high dividend yield approach that remains conservative. The fund’s bias towards value has unfortunately limited total upside as growth strategies have outperformed. As many investors are aware, a substantial portion of the S&P 500’s return has been generated by information technology and other tech-oriented segments. In fact, Information Technology has led returns by sector in 2017, 2019, and 2020. As a result, VYM’s value orientation has missed a substantial portion of the S&P 500’s total return, especially in recent years.
Source: Novel Investor
While we understand VYM’s strategy differentiates from growth-oriented investing, the performance difference should be considered. In theory, dividend-producing equities should outperform in times of stress due to their reliable cash flows anchoring performance. The theory did not pan out, as VYM’s peak to trough drop into COVID-19 was similar to the S&P 500.
Although valuations remain stretched to unbelievable levels, the tech sector has continued to outperform the broader market. The dominance of mega-cap technology firms such as Apple (AAPL) and Microsoft (MSFT) has resulted in dramatic outperformance as compared to VYM. Should the growth in mega-caps continue, VYM could continue to fall further behind other ETFs.
Conclusion
VYM is a strong performer with a solid value proposition given the management team and industry-leading expense ratio. The fund offers exposure to large-capitalization domestic equities with a concerted focus on producing high current yield. The fund’s passive management provides an index-linked approach which excludes the potential for outperformance when compared to active rivals. The ETF is scalable, transparent, and convenient with a reliable stream of dividends. The results are a popular ETF with a stable history. We would consider VYM to be a core holding. Given the current economic outlook, VYM should continue to provide shareholders a growing stream of dividends.
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REITer's Digest
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I am a real estate professional with nearly a decade of experience across valuation, research, and portfolio acquisitions. Having spent my career with a big four firm and an S&P500 real estate investment trust, I am intimately familiar with the public real estate markets and REIT analysis.I created REITer’s Digest to share my thoughts and expertise on real estate, REITs, and fundamental investing concepts to help investors make informed decisions.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of VYM, VNQ, SPY either through stock ownership, options, or other derivatives. 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.
This article is not to be considered investment advice. Research provided in this article is supportive of your own thorough and complete due diligence. Please consult your investment advisor on opportunities presented herein.
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