Author’s Note: This article was released to members of the CEF/ETF Income Laboratory on August 1, 2022.
The AAM S&P 500 High Dividend Value ETF (NYSEARCA: SPDV) is an equally-weighted U.S. equity index fund with a focus on high-dividend stocks and free cash flow returns. SPDV’s strategy has failed in previous years, leading to moderate underperformance. Performance has improved in recent months, with the fund outperforming for about a year. SPDV’s above-average yield of 3.4% and cheap valuation make the fund a buy.
SPDV – Basics
- Investment Manager: Asset Management Advisors
- Dividend yield: 3.48%
- Expense ratio: 0.29%
- CAGR of total returns (creation): 6.76%
SPDV – Overview
SPDV is a US equity index ETF, which tracks the S&P 500 Dividend & Free Cash Flow Yield Index. This index differs from the broader S&P 500 index in three main ways:
- Sectors and stocks are weighted equally, reducing exposure to technology, while increasing exposure to old-economy industries like energy, materials and real estate
- Focuses on stocks with above-average returns, resulting in a fund with an above-average return of 3.5%
- Focuses on stocks with high free cash flow yields, resulting in a fund with a relatively cheap valuation, and therefore larger potential capital gains
SPDV, as a fund and as an investment opportunity, is defined by the three points above. As such, let’s take a closer look at each of them.
Equally weighted sectors
SPDV invests in five different US stocks from each relevant industry segment, subject to a set of basic criteria of liquidity, trading, size, turnover, etc. There are eleven different industry segments, so the fund is typically invested in 55 different stocks, excluding short-term positions during rebalances etc. SPDV’s diversified sector exposures and large number of holdings make it a reasonably well-diversified fund, but the diversification is significantly lower than the average for a US equity index fund, most of which invest in hundreds of stocks.
SPDV’s sectors are equally weighted. Most stock indices, including the S&P 500, are weighted by market capitalization, which has important implications for investors. The S&P 500 is massively overweight in technology, due to the outsized influence of mega-cap tech companies, including Microsoft (MSFT) and Apple (AAPL). On the other hand, the S&P 500 tends to underweight certain small old-economy industries, including energy, materials and real estate. SPDV’s sector weightings are all the same, so the fund’s performance can at times differ materially from that of the S&P 500. SPDV tends to outperform significantly when technology underperforms, as it has since the beginning of the year, in which technology valuations (started) to normalize.
SPDV’s sector weightings are very different from those of the S&P 500 / most equity indices, an important fact for investors to consider.
SPDV assets are also equally weighted, so the fund invests more in the mid-cap sector relative to the S&P 500.
SPDV holdings include most of the major well-known companies non-technical companies, including Exxon (XOM), Pfizer (PFE) and Altria (MO). At the same time, the fund excludes most large-cap tech companies including Microsoft, Amazon (AMZN) and Google (GOOG), with the fund investing instead in smaller tech companies like Cisco (CSCO) and IBM (IBM) . SPDV’s exclusion of mega-cap tech companies reduces diversification, at least relative to the S&P 500 and similar indexes. The exclusion of these companies is quite rare for a US equity index fund, and it is important for investors to take this into account. Investors looking for significant diversification, exposure to the high-growth tech industry or to these specific companies should probably consider other funds.
High dividend yield
SPDV focuses on stocks with above-average dividend yields, leading to an above-average yield of 3.5% for the fund. While this is by no means a fantastic yield, it is above average, and a benefit for SPDV and its investors.
Although the fund’s dividends are above average, they are significantly lower than those offered by the highest paying asset classes and funds. MLPs, BDCs, mREITs and most CEFs yield just over 3.4% and might be more suitable choices for investors looking for income.
High free cash flow yield
SPDV focuses on stocks with above-average free cash flow yields, a key valuation measure. Focusing on these stocks results in a fund with a relatively cheap valuation, above all in the targeted metric, as expected. SPDV’s valuation metrics, relative to the S&P 500, are as follows.
SPDV’s relatively cheap valuation offers two key advantages to investors.
First, cheap valuations can always normalize, leading to significant capital gains and above-market returns. Ratings have started to normalize since at least early 2021, with some volatility and some reversals. SPDV has since outperformed, as expected. SPDV remains cheap, so further gains are likely, at least in my opinion.
Second, SPDV’s cheap valuation means investors in the fund are entitled to plenty of assets, income and cash, regardless of market conditions. For example, SPDV has a free cash flow yield of 15.7%, compared to the S&P 500 FCF yield of 3.8%. SPDV’s underlying holdings generate a lot liquidity, regardless of market conditions, investor sentiment or stock price fluctuations. This cash can be used to strengthen the price and returns of an investment, through dividends, redemptions, strategic investments, etc. Invest in an asset that generates 15.7% cash will be net returns you around 15.7% sooner or later. At least assuming that cash flow generation remains strong.
A corollary of the above is that cheap valuations can also, in certain circumstances, reduce risk. In a bear market, companies with free cash flow yields of 15.7% can easily pay massive dividends or engage in large buyback programs. These moves would increase investor demand for the company’s stock, increasing returns/reducing bear market losses. Companies with free cash flow yields of 3.8%, so the average S&P 500 company, don’t generate enough cash to fund large dividends or buybacks, and would therefore bear the brunt of any downturn.
Either way, SPDV’s cheap valuation could potentially lead to significant capital gains and above-market returns, a benefit to the fund and its shareholders.
SPDV – Performance Analysis
Finally, a brief word on the fund’s performance.
The performance record of SPDV is quite simple. The fund stands out from its index in three main ways: equally weighted sectors, concentration on stocks with a high dividend yield, concentration on stocks with a high free cash yield. The fund outperforms when all three strategies outperform, as has been the case since the start of the year. The fund underperforms when said strategies underperform, as it did before 2022 / in the past three years. SPDV’s performance is as follows, I have included data for the S&P 500 and several funds tracking each of SPDV’s individual strategies, for reference.
Conclusion – Buy
SPDV’s above-average yield of 3.5% and cheap valuation make the fund a buy.