Vanguard High Dividend Yield ETF – The Good And The Bad (NYSEARCA:VYM)


Introduction

The Vanguard High Dividend Yield ETF (VYM) offers investors exposure to stocks characterized by high dividend yields by closing tracking the FTSE High Dividend Yield Index. In this article, I will expand on some of the potential good and bad qualities associated with an investment in this ETF.

The Good

The dividend angle

In an environment, where yield is hard to come by, an ETF that can offer you a consistent yield of more than 3% (4-year average is c. 3.2%) is rather sweet; at the current share price, the yield is even more appetizing at 3.43% (the dividend yield in 2020 has been the highest it has ever been). These dividend yield plays will take on more prominence as we are in the midst of relatively over-extended markets, coupled with an uncertain economic outlook; these twin scenarios mean the probability of returns through significant capital appreciation may be unreasonable. To negate the potential shortfall of total return, a consistent yield of 3% would be most welcome. Do also note that dividends have grown every year for the last 10 years at a CAGR of 9.3%.

An ideal proxy for large-cap value

Source: Vanguard

Over the last few years, financial blogs and articles have been awash with the death of the value-style stocks so I can appreciate it if investors remain wary of this segment. That said, I do feel this negative pitch has been overdone and I think one could see a rotation into value-style names in the near future. Currently, the value over momentum ratio is hovering at record lows, well below the previous lows of 1x last seen during the dot-com bubble. At such overstretched levels, I don’t think it can drift any lower, and feel we are not too far away from a pullback in this ratio.

Source: Bloomberg

In fact, one may already have seen the advent of this value/growth mean-reversion theme last month, with value outperforming growth for the first time after 11 months. Going forward, analysts believe key-value segment such as banks and industrials are poised to grow twice as much as tech and the other growth segments (Source: Bloomberg Intelligence).

Source: Bloomberg

Interestingly, do also consider that over the last 40 years, after every presidential election, value stocks have outperformed growth, regardless of the outcome.

Then potential stocks for VYM are ranked based on the forecasted dividend yield, and then weighted based on market-cap rather than the dividend. This invariably tilts this ETF towards large-cap names. At this stage of the cycle, when the economic outlook is still uncertain, and balance sheets are overleveraged and in a bad shape, it would be preferable to be more exposed to large-cap names as their balance sheets and cash flow positions are more resilient and they also have the firepower to weather the storm and cope under adverse conditions or pick up smaller assets and build their positions.

Well-diversified and well-spread out with favorable sector exposure

Source: Yahoo Finance

VYM gives you exposure to more than 400 high-dividend yield stocks, the most in this space, and almost twice as much as the next big peer-VIG. When it comes to the high dividend yield space, I believe it is preferable to spread your bets over a larger pool of securities as most of these securities “tend” to have high yields on account of low share prices (denominator effect), which in turn is indicative of weak business prospects. Thus, you don’t want to get too exposed to a small pool of securities. This large pool of VYM also means that the impact of the top-10 holdings too is not too profound, making up only one-fourth of the total holdings.

Given how ambiguous the medium-term economic outlook looks, I also like the sectors that VYM is currently mainly exposed to; VYM feels like a well-hedged ETF that could cope with different economic scenarios. Firstly, there is no single dominant sector by far, plus all the key sectors are an interesting mix of cyclicals, defensives, and growth.

Within the key large sectors, you have the financials at 18%. On account of the low-rate environment we find ourselves in, investors’ appetite for financials have taken a back seat for much of 2020, but I think we could see some rotation back into this space as we close the year and enter 2021. If we see a cyclical upswing next year, you’d want exposure to these financials. Yes, low-interest rates are not ideal for NIMs, but in Q1 and Q2 of this year, a lot of these financials made some huge provisional buffers to prepare for adverse credit risks. As you can see from the chart below, provisioning has gone through the roof in H1. The credit risk has not been as bad as feared and I believe we could see some provisioning release come through in Q3 and Q4, which could potentially result in some bottom-line surprises. You also have a number of financials that have strong exposure to the hot housing and mortgage segment and I expect this to be reflected in superior mortgage servicing fees. A lot of these financials have also curbed their repurchases in H1, so their capital buffer levels too are quite resilient to withstand further pressures.

Source: S&P Global

If the cyclical upswing doesn’t go to plan, and if the health pandemic’s effects continue to linger, VYM also offers you a solid defensive tilt with exposure to the consumer staples and the healthcare segment both of whom account for c.32% in aggregate and are the next two biggest segments.

Despite lofty valuations, there are many who think, that high-price tech will continue to flourish in this low rate environment; the sector is also increasingly being seen as one that has defensive qualities. VYM’s exposure here is around 11%.

Source: Seeking Alpha

Efficient and relatively cheap-valued

VYM follows a passively managed, full replication approach, which means its expense ratio is best-in-class, at a meager 0.06% making it one of the most efficient ETFs around. Its tracking efficiency is also reflected in a rather high R-square of 93 (i.e. 93% of the fund’s movements can be explained by what happens in the benchmark index), which is also better than other peers in this space (See risk-adjusted return table in the risk segment below).

Large sections of the market feel overvalued but VYM’s current valuations are not undemanding and are relatively cheaper than all the key market indices. The ETF currently trades at a P/E of 17.7x which is more than 50% cheaper than the corresponding P/E multiples of the S&P500 (38x) and the Nasdaq (36.7x) and 35% cheaper than the DJIA (27x)

Bullish price action on the daily and weekly charts

I’ve been somewhat encouraged by the recent price action of VYM, especially on the lower time frame charts, such as the daily chart and the weekly chart. On the weekly chart, after some intense selling in March, VYM has bounced back from the lows of $60 and is currently in the midst of forming- what we call in technical parlance- a bullish pennant. After rebounding to levels of $88 in early June, VYM has been consolidating in a tight range of $76-$86, providing an opportunity for interested participants to build some positions amidst low volatility. A decisive break above the $88 levels could see the ETF potentially retest the previous resistance of $96, which represents around 14% upside from current levels.

Source: TradingView

On the daily charts, the triggers for bullish momentum are coalescing. Since late September, the price action has been very encouraging with the ETF breaking past the key moving averages (the 50-DMA, the 100-DMA, and the 200-DMA). In early October we saw, the bullish golden cross pattern with the 50-DMA overtaking the 100-DMA, and now, we are on the cusp of witnessing the 100-DMA overtake the 200-DMA. Broadly all these conditions suggest that bullish momentum is on the cards. Alternatively, after a strong up move over the last month or so, we may also see the three DMAs congregate in a tight range (this is indicative of volatility contraction), and the ETF may take a pause and continue to drift sideways before resuming an up move later on.

Source: TradingView

The Bad

Unappealing historical risk-adjusted returns

Source: Yahoo Finance

At the onset, let me state that VYM’s recent historical risk-adjusted profile (3 years and 5 years basis) is not too pleasing (i.e. for the level of risk it takes, the quality of returns is sub-par). Of course, it goes without saying that “past performance is no guarantee of future results”, but it’s important that investors know what they’re getting into whilst dealing with a fund of VYM’s ilk.

Firstly, even without considering the risk angle and only looking at mean annual returns, you can see that VYM lags the category average quite significantly. Then, VYM and its category, are not high-beta plays (less than 1x beta), so the reactiveness to the benchmark returns are less severe. Despite its relatively low-beta characteristics, VYM has not been able to generate superior excess returns (returns over the risk-free rate) that peers in the category have been able to deliver (Treynor ratio of 1.86 vs 11.86 for peers over the last 3 years).

Even if you look at things from a total risk perspective (standard deviation) and not just systematic risk, one can see that the volatility of VYM is a lot more severe than the category average. This has meant that VYM has not been able to generate any superior excess return for the per unit of total risk taken (Sharpe ratio); others in this category have been able to generate excess returns on par with the per unit of risk taken (Sharpe ratio of 1 for the category average vs 0.18 for VYM).

Ambiguous price action on the monthly charts

Whilst the price action on the daily and weekly charts are quite encouraging, on the larger time frame- monthly chart, the situation is rather inconclusive. As you can see from the monthly chart, from 2016-2018 the price action was definitely bullish, but since around 2018 or so, VYM has been chopping around in what is known as a broadening wedge/triangle pattern. This is indicative of general indecisiveness amongst the market participants. After bouncing back from the lower boundaries of the wedge (at around the $67 levels) in March/April, the ETF has now come into a zone ($82-$88) which had previously served as a zone of accumulation from Jan 2018 to Sep 2019. We could potentially see a repeat of this at these levels.

Source: TradingView

Closing thoughts

I think VYM may be suitable as a medium-term option for the next six months or so. If you’re someone who thinks that the value style is due a comeback, VYM is a decent way to exploit this theme as it’s inexpensive, well-diversified, efficient, and you also get the cushion of a 3% plus yield in case things don’t go to plan. The sectoral exposure has a nice mix of potential defensiveness as well as the potential for returns, in case we see a cyclical upswing. On the daily and weekly charts, the current momentum is bullish but on the larger time frame, things are inconclusive. VYM’s historical risk-adjusted return stats too don’t make for pleasant reading. The sub-par risk-adjusted stats and fairly neutral long-term monthly chart means this is not an ETF you want to hold for too long.

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.

Be the first to comment

Leave a Reply

Your email address will not be published.


*