FDL ETF Leads The High-Dividend Category For Now (NYSEARCA:FDL)

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Investment Thesis

Over the last year, the First Trust Morningstar Dividend Leaders (NYSEARCA:FDL) was the best-performing high-dividend ETF. Though Morningstar’s process of selecting 100 of the highest-yielding U.S. stocks most likely able to sustain their dividend payments hasn’t always benefited shareholders, it’s evident that adding Energy stocks back into the mix last June was pivotal. These are the changes investors need to watch out for in two months when the Index reconstitutes next, but in the meantime, this article aims to assess the likelihood of FDL continuing its hot streak.

After performing an update of the fundamentals for all 64 dividend ETFs I track, FDL remains top of its class, especially among those with forecasted yields above 3%. Specifically, investors should benefit from an estimated net yield of 3.56%, a 9.05% forward EPS growth rate, a low beta of 0.79, and an attractive forward P/E ratio of 13.79. While high-dividend ETFs aren’t as appealing as they were a few months ago, FDL still has some room to run, and if you’re already a holder, I don’t think there’s any reason to let go.

ETF Overview

Strategy and Fund Basics

FDL tracks the Morningstar Dividend Leads Index, selecting the 100 highest-yielding U.S. securities (excluding REITs) believed capable of sustaining their dividend payments. Companies with negative five-year forward dividend growth rates are excluded, as are those with dividend payout ratios exceeding 100%. The Index is rebalanced quarterly and reconstituted annually in June, and I’ve listed some additional descriptive statistics below.

  • Current Price: $38.45
  • Assets Under Management: $1.90 billion
  • Expense Ratio: 0.45% (Capped Until At Least April 2022)
  • Launch Date: March 9, 2006
  • Trailing Dividend Yield: 3.46%
  • Five-Year Dividend CAGR: 9.03%
  • Ten-Year Dividend CAGR: 7.98%
  • Dividend Frequency: Quarterly
  • Five-Year Beta: 0.95
  • Number of Securities: 100
  • Portfolio Turnover: 59% (43%, 39%, 39%, and 63% from 2017-2020)
  • Assets in Top Ten: 58.35%
  • 30-Day Median Bid-Ask Spread: 0.03%
  • Tracked Index: First Trust Morningstar Dividend Leaders Index
  • Short-Term Capital Gains Tax Rate: 40%
  • Long-Term Capital Gains Tax Rate: 20%
  • Tax Form: 1099
  • Annual Report Link: Here

The main takeaways are FDL’s strong dividend yield and a nearly double-digit five-year dividend growth rate. While a high yield is more likely with FDL, growth isn’t a feature. Remember, the screen is for the sustainability of dividend payments, not growth. Anything extra is a bonus, but as you’ll see later, FDL’s current constituents possess many of the same features of high-dividend-growth stocks, including a relatively low 57% payout ratio and solid sales and earnings growth to back it up.

I also want to touch on fees, which are high at 0.45%. Adding to this problem is a poor historical tracking error. With an efficient ETF, one would expect the difference between the Index’s return and the ETF’s return to be the fees. However, FDL’s ten-year returns were 0.59% worse than the Index (11.82% vs. 12.41%) as of March 31, 2022. Moreover, 6.53% of your gains (assuming a 10% annual return) will be lost to fees over ten years compared to 0.88% for a low-fee choice like the Schwab U.S. Dividend Equity ETF (SCHD). In my view, FDL’s Index stands a much better chance of closing the gap over the near term, so I recommend taking it one year at a time. High-fee dividend ETFs aren’t suitable long-term holdings.

FDL Performance History

First Trust

Sector Exposures and Top Ten Holdings

The table below highlights FDL’s sector exposures alongside three other high-dividend ETFs:

  1. SPDR Portfolio S&P 500 High Dividend ETF (SPYD)
  2. Global X SuperDividend US ETF (DIV)
  3. Invesco S&P 500 High Dividend Low Volatility ETF (SPHD)

FDL vs. SPYD vs. SPHD vs. DIV Sector Exposures

Morningstar

As shown, FDL is overweight Health Care by approximately 10% more than SPYD and SPHD and about 18% more than DIV. FDL is also heavy in Communication Services and Technology stocks but has no exposure to Real Estate. SPHD is most similar in terms of volatility. While FDL has a five-year beta of 0.95, its constituents’ weighted-average five-year beta is only 0.79.

The top ten holdings are listed below, totaling 58.35%. The Communications Services exposure is essentially AT&T (T) and Verizon (VZ), but several Dividend Aristocrats are included like AbbVie (ABBV), Chevron (CVX), and Coca-Cola (KO). Expect AT&T to be dropped in June since it announced a 50% cut on February 1 related to the spin-off of its media business.

FDL Top Ten Holdings

First Trust

Historical Performance

I want to look at FDL’s historical performance in several ways. The graph below shows returns against two plain-vanilla ETFs tracking broad-based market indexes: the SPDR S&P 500 ETF (SPY) and the iShares Russell 1000 ETF (IWB).

FDL vs. SPY vs. IWB Performance History

Portfolio Visualizer

This first graph is typical of most high-dividend ETFs. Relative performance is solid until around 2015-2016, but then the tech-fueled bull market takes off, and the broad-based ETFs substantially outperform. Annualized returns since April 2006 were nearly 2% lower for FDL, and its drawdown of 61.67% between June 2007 and February 2009 was much worse than SPY or IWB.

Looking at more recent history and comparing it with FDL’s high-dividend peers paints a better picture. The following graph highlights performance against SPYD, DIV, and SPHD since November 2015. Though high-dividend ETFs substantially underperformed during this period, FDL was one of the better funds to own.

FDL vs. SPYD vs. DIV vs. SPHD Performance History

Portfolio Visualizer

Finally, here is a list of all the high-dividend ETFs I currently track. I’ve sorted them by the six-month returns column, showing that FDL was the best performer in that period. SPY gained 5.94% from October to March, meaning all high-dividend ETFs outperformed the market. It’s quite the reversal from even just a few years ago.

High-Dividend ETF Performances

Author

Dividends

FDL’s dividend growth history is below. As mentioned before, dividend growth isn’t an explicit part of the strategy, hence why annual growth is sometimes negative like last year. The key draw is the high yield, but even that bounces around quite a bit. It reached as high as 10.10% during 2008 when asset prices were depressed but ended 2021 at 3.65%. Today, the trailing yield is 3.46%, reflecting how high asset prices have climbed since the pandemic.

FDL Dividend Growth History

Seeking Alpha

If you rely on dividend payments to cover your day-to-day living expenses, FDL and other high-dividend ETFs may not be appropriate for two reasons:

1. ETFs are just baskets of securities, nothing more. Remember that FDL doesn’t grow its dividends; its underlying holdings do. If an ETF reconstitutes, resulting in the selection of lower-yielding stocks than before, your distributions ultimately will be lower. There’s no way around that, so start with what the underlying holdings yield today if you want to forecast distributions.

2. If a significant number of ETF units are created between the time the underlying holdings make their distributions, and when the ETF makes its distribution, your dividends will be diluted. A recent example is with SPYD, where frustrated investors saw their Q4 2021 distribution cut by 67% over the prior quarter. You can read my analysis and take on that ETF here.

Fundamental Analysis

In my July 2021 review, I highlighted the reconstitution risks inherent with owning FDL. To illustrate, between July 2019 and June 2021, the Index adjusted its exposure to Energy stocks at the worst times. FDL had over 20% in Energy as the sector fell 43%. Then, in June 2020, energy stocks were removed, just before the sector gained 50%. FDL underperformed SPY by 32.52% over those two years, and I’m confident these poor decisions would have been avoided had the fund been reconstituted on a different date or at more frequent intervals. Previously, I questioned whether this was just poor timing or a critical design flaw with the Index, but the answer is moot. As an investor, the only thing you can do to mitigate this reconstitution risk is by examining the changes each year. Therefore, while I believe my analysis of the fund today is accurate, it may become irrelevant in two months.

I’ve highlighted FDL’s top 20 holdings below. Note how I have set AT&T’s forward revenue and EPS growth metrics to be flat. The metrics listed on Seeking Alpha’s quote page are technically correct but probably don’t represent the company today.

FDL vs. SPHD Snapshot By Company

Author

In my view, FDL leads SPHD nearly across the board. FDL should deliver a slightly better dividend yield this quarter, even after adjusting for its higher fees (0.45% vs. 0.30%). Its constituents also have a better dividend growth history (9.77% vs. 7.90%). Not shown, but FDL has a lower dividend payout ratio (57% vs. 75%) and a better cash to total debt ratio (36% vs. 24%). It seems FDL is a higher-quality portfolio, but SPHD has done very well recently, too. I think it’s because of the high exposure to Utility stocks, which I favor.

FDL also has a 9.05% and 9.63% forward revenue and EPS growth rate, which are better than SPHD’s. Having some growth potential is essential because otherwise, you’ll significantly underperform in bull markets. Its valuation is best-in-class, though. FDL’s forward P/E of 13.79 ranks fourth out of all high-dividend ETFs listed earlier (slightly behind GBDV, SDOG, and WBIY). However, those three have estimated five-year betas of 0.93, 0.96, and 1.04, so you won’t get the same downside protection.

One critical risk is FDL’s high concentration, with over 95% allocated to just 20 industries. I favor diversification, so this is another reason why I’m hesitant to recommend it as a long-term holding. However, you can hold a variety of high-dividend ETFs to mitigate this risk. I’ve put together a table showing the industry concentrations for ten peers relative to FDL. You can use this to guide how well FDL may fit into your existing portfolio.

FDL Industry Concentration Analysis

Author

For example, DHS and HDV each have about 80% allocated to the same 20 industries as FDL. Unless you’re incredibly bullish on FDL’s overweighted industries like Integrated Telecommunication Services, there’s probably no reason to own more than one. In contrast, adding FDL makes sense if you already own the SPDR S&P Dividend ETF (SDY). SDY is well-diversified but focused on Regional Banks (7.71%) and Gas Utilities (6.22%), so it’s different enough and appropriate should you want to corner the high-dividend segment.

Investment Recommendation

FDL is a buy today due to its low valuation and volatility, decent revenue and earnings growth rates, and a relatively high estimated dividend yield of 3.50%. If the market continues to favor these factors, FDL will likely remain near the top of the high-dividend category. However, past reconstitutions were dramatic, so investors need to be careful. Sometimes the changes work out, and sometimes they don’t, so keep an eye out for the differences in late June, and if FDL doesn’t hit in your portfolio anymore, be ready to sell.

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