Two Top-Performing Dividend Strategies for a Choppy 2016

Two Top-Performing Dividend Strategies for a Choppy 2016

So far, 2016 is proving to be a tough year to make money in U.S. stock markets.

The S&P 500 has gained a mere 1.31%, including dividends, and it is trading at levels it first saw in June 2014. That means that to make money in the U.S. stock market, you have two choices.

You can be a sharpshooting stock picker, choosing profitable stocks with remarkable accuracy. Or you can pursue a path of less resistance and invest in dividend stocks, relying on steady and predictable cash flows to churn out gains month after month.

Certainly, investing in the dividend strategy has proven to be the better choice in 2016.

Below, I discuss two strategies that generate consistent gains, even as the broader market treads water.

Each exchange-traded fund discussed is also a long-time holding in my personal investment portfolio.

I. The Dividend Aristocrats

The “Dividend Aristocrat” investment strategy is based on the premise that buying large-cap stocks with decades-long track records of increased payouts will deliver investors total returns that exceed those of just “buying the market” with an S&P 500 Index fund.

To be a Dividend Aristocrat, a stock must meet two requirements.

First, it must be a member of the S&P 500.

Second, it must have a history of at least 25 years of increasing annual dividends.

The current tally of S&P 500 companies that meet both of these requirements is 50.

Standard & Poor’s has been tracking the performance of these stocks since 2005 through the S&P Dividend Aristocrats Index.

And according to Bloomberg, the S&P 500 Dividend Aristocrats Index has outperformed the S&P 500, with lower volatility, since its inception.

And in what amounts to that ever elusive “free lunch” of higher returns with lower risk, the index tends to capture 90% of the upside of the S&P 500, while suffering only 70% of its drawdowns.

The ProShares S&P 500 Dividend Aristocrats ETF (NOBL) is an exchange-traded fund (ETF) that tracks this strategy. Although the strategy is old, NOBL itself is quite new, having launched only in October 2013.

Year to date, ProShares S&P 500 Dividend Aristocrats ETF (NOBL) has posted a total return of (including dividends) 6.36%.

By way of comparison, the S&P 500 Index has delivered investors a total return of 1.31%.

S&P 500 vs. NOBL year to date

With an expense ratio of just 0.35%, the cost to own the Aristocrats Index is more expensive than a standard Vanguard S&P 500 Index fund. But with the Dividend Aristocrats strategy outperforming its Vanguard rival both on an absolute and risk-adjusted basis, the higher management fee seems worth it.

II. The Dividend Dogs

While the Dividend Aristocrats seek out the best in the market, the “Dividend Dogs” strategy bets on the worst — and with surprisingly good results.

The Dividend Dogs strategy is a close cousin of the “Dogs of the Dow” theory, popularized by Michael Higgins in his book, “Beating the Dow.”

The Dogs of the Dow are the 10 of the 30 companies in the Dow Jones Industrial Average that have the highest dividend yield.

The strategy is simple. Invest in the 10 highest-yielding stocks in the Dow, and rebalance at the end of each year.

A fundamentally contrarian strategy, the Dogs of the Dow invests in currently out-of-favor stocks, which are expected to rebound. Once they do, you replace them with other newer Dogs that are temporarily out of favor.

Much like the Dividend Aristocrats strategy, the Dogs of the Dow strategy works surprisingly well.

Between 1957 and 2003, the Dogs outperformed the Dow by about 3%, averaging a return of 14.3% annually whereas the DJIA averaged 11%. The performance between 1973 and 1996 was even more impressive, as the Dogs returned 20.3% annually, whereas the Dows averaged 15.8%.

Today, there is no single ETF that replicates this strategy. Perhaps the strategy is just too simple.

Enter the ALPS Sector Dividend Dogs ETF (SDOG), which applies the “Dogs of the Dow” theory on a sector-by-sector basis to stocks trading in the S&P 500.

Although this strategy does not have the long track record of the S&P Dividend Aristocrats Index, the idea behind it — and its performance — makes the approach compelling. SDOG invests in the five highest-yielding securities in each of the 10 sectors of the market. This generates a portfolio of 50 stocks with a focus on the large-cap market. By weighing each sector equally at the stock and sector level, SDOG provides diversification while avoiding sector biases.

Like the Dogs of the Dow strategy to which it owes its fundamental insight, the idea is contrarian. Higher-yielding stocks in the S&P 500 are expected to recover, bringing their yields in line with the market, and leading to outsized gains.

S&P 500 vs. SDOG year to date

Year to date, the ALPS Sector Dividend Dogs ETF has posted a total return (including dividends) of 9.76%, far above the S&P 500 Index’s 1.31%.

For income-oriented investors, the fund’s 3.24% yield bests the S&P 500 Index’s yield of 2.1%. SDOG charges a reasonable 0.40% in annual fees.

In case you missed it, I encourage you to read my e-letter column from last week about the unique private equity course offered at Oxford. I also invite you to comment in the space below.