Location Pays Dividends

by Justin Lowry, President & CIO, Global Beta Advisors, LLC

Location, location, location. The adage that everyone in real estate echoes as the most important point of value for property. Well, that also rings true in the public markets. As equity markets continue to trade at record high valuations and bond markets continue to see record-low yields, thanks in large part to an abundance of Federal stimulus, it has left investors both complacent and uncertain in how to position from here. What’s of further concern is that both parts of the market have created a dire situation for yield, which has pushed investors to seek alternative solutions such high-risk credit or purchasing crypto-based assets that earn interest. The following chart illustrates the current yield landscape across various asset classes. The black line indicates the most recent annualized month-over-month inflation reading from the bureau of labor.

investment analysis


Yields Across the Spectrum

Source: FactSet Research Systems. Measures the 12-month trailing yield in the underlying assets for the 3-month treasury bill, 2-year bond, 5-year bond, 10-year treasury bond, Bloomberg Barclays Aggregate Index, Markit IBoxx USD Liquid High Yield Index, and Global Beta Smart Income Index as of 7/31/21.

The line indicates annualized growth of the consumer price index from June 2021 to July 2021.

Coinbase Crypto Yield source from Coinbase. Based on interest being offered to clients holding crypto-based assets at Coinbase.


As you can see, fixed income assets across the board hold net negative yields.  In other words, their yield to maturity is less than the rate of inflation, as indicated in the chart above.

Of course, this is concerning if inflation of this magnitude sustains itself as investors in bond markets would not earn enough to meet the demands of inflation.  Therefore, the question then becomes whether the economy realizes persistent levels of inflation.  We believe crypto-based assets are too novel to truly know if they offer protection versus inflationary periods.  It is a hotly debated topic, but in the end, with such a limited track record, it’s difficult for anyone to know with certainty.  Of course, the bond market is particularly susceptible to inflation as it poses the risk for rising interest rates.  This would be particularly bad for higher risk credit.  However, at this point, based on where yields are in the bond market across the risk spectrum, investors are seemingly betting against the prospect that inflation is here to stay.

What if inflation persists?

This has turned into the $64,000 question.  Given the uncertainty, we believe the risk-reward prospect in the bond market is too high, and we believe crypto-based assets are too novel to trust versus potential inflation.  Therefore, we believe equities with attractive valuations and strong balance sheets are likely the safest bet in the near to medium term.  If inflation does persist, investors will enjoy the natural upside of increased asset prices.  If inflation proves to be transitory, investors will be able to collect strong and sustainable dividends.  This is not to say that investing in these companies are risk free as investing in equities always comes with greater risk than the bond market.  However, given the current situation, we believe the risk-reward proposition in equities with attractive valuations that pay strong dividends provides investors with the best overall value.  In fact, history has shown that dividend-oriented strategies tend to offer the best medium-term outlook.  Below is a chart illustrating the average five-year annualized forward returns following periods where the consumer price index increased by more than 2% year over year for each market factor that we measure:


5-Year Forward Return Following Inflation

5-Year Forward Return following Inflation

Source: FactSet Research Systems (12/31/08 through 03/31/21). “Low Volatility” is represented by data from the MSCI US Minimum Volatility Index, “Growth” is represented by data from the S&P 500 Growth Index, “Value” is represented by data from the S&P 500 Value Index, “Yield” is represented by data from the Dow Jones US Select Dividend Index, “Quality” is represented by data from the S&P 500 Quality Index, and “Size” is represented by data from the S&P 600 Index.


We find the above chart to be pretty revealing in terms of asset classes that pay off during periods of inflation.  Again, it’s difficult to forecast with any certainty whether inflation will persist or not, but we believe the risk-reward scenario of collecting dividends from companies with strong balance sheets is more favorable to that of the bond market or more novel investments, considering its track record.

Where can investors find yield?
Global Beta believes balance and valuation are important components when investing in any asset class or factor.  We believe balance is sometimes overlooked when investors seek yield.  Oftentimes, investors find themselves highly concentrated in real estate investment trusts, master limited partnerships and utilities as a means of achieving yield from equities.  However, in taking this approach, investors will be left overexposed and vulnerable to changing market and economic circumstances.  For example, utilities companies generally take more debt onto their balance sheet to sustain their dividend payments without disrupting operating cash flow.  However, when interest rates rise, highly indebted companies become vulnerable and cash strapped.  This is why Global Beta takes the approach of incorporating every segment of the market when seeking yield.  Additionally, Global Beta precludes securities that have cut their dividends, regardless of size, as a quality screen.  Global Beta believes that sustainable dividends are just as important as the yield itself.  Therefore, a company with an 8% yield that has recently cut its yield has a greater risk profile than a company with a 3.5% yield that has recently increased its yield.  We believe that allocating to companies with higher 12-month trailing revenues also enhances our exposure to more stable and more attractively valued companies.  In fact, as of June 30, 2021, 45 of the 90 companies tracked in the Global Beta Smart Income Index increased their quarterly dividends from one year prior.  Additionally, 7 of the top 10 holdings increased their quarterly dividends over the past year.  The index grew its quarterly dividends by a weighted average year-over-year basis of 1.22 percent.  Below is top down and bottom up overview of the index as well as its risk characteristics:


Global Beta Smart Income Index Sector Breakdown (as of 7/31/21)

Portfolio Weight Dividend Yield Price-to-Earnings Price-to-Sales Market Capitalization
Global Beta Smart Income Index 100.0 4.11 19.1 1.66 73,715
Communication Services 7.47 5.26 12.8 1.09 145,383
Consumer Discretionary 2.04 3.56 15.8 1.44 8,053
Consumer Staples 11.72 4.72 18.2 0.95 76,288
Energy 8.08 6.33 21.5 2.51 150,111
Financials 20.33 3.13 8.4 1.61 28,067
Industrials 4.70 3.00 19.1 0.99 86,542
Information Technology 7.02 4.20 21.2 1.62 86,202
Materials 10.65 4.20 13.4 1.30 33,885
Real Estate 2.72 4.22 78.7 7.28 18,035
Utilities 13.39 3.84 27.8 2.57 56,584

Source: FactSet Research Systems (07/31/21)



Global Beta Smart Income Top 10 Holdings (as of 7/31/21)

Ticker Name Portfolio Weight Dividend Yield Price-to-Earnings Price-to-Sales Market Capitalization
Global Beta Smart Income Index 100.0 4.11 19.1 1.66 73,715
PGR Progressive Corporation 4.84 0.42 10.2 1.31 55,688
PFE Pfizer, Inc. 4.57 3.62 18.3 5.75 239,693
IBM International Business Machines Corporation 4.54 4.63 23.8 1.72 126,345
XOM Exxon Mobil Corporation 4.54 6.04 1.38 243,751
CAH Cardinal Health, Inc. 4.53 3.28 28.5 0.11 17,280
VZ Verizon Communications, Inc. 4.52 4.50 11.6 1.80 230,936
PRU Prudential Communications, Inc. 4.52 4.49 5.5 0.70 38,785
WBA Walgreens Boots Alliance, Inc. 4.49 3.97 17.9 0.30 40,779
DOW Dow, Inc. 4.11 4.50 11.4 1.20 46, 357
MMM 3M Company 3.50 2.98 19.5 3.58 114,536

Source: FactSet Research Systems (07/31/21)


As you can see by the above sector allocations, the result of the portfolio is fairly balanced but demonstrates a 12-month trailing yield above 4%.  Given the forecasted economic uncertainty, we believe balance, yield, and valuations are going to be cirtical for investors.  Therefore, as the adage goes; location, location, location.

 


 

Disclosure

Yield to Maturity is the total rate of return bonds return to shareholders upon the maturity.

12-month trailing yield/Dividend Yield is the sum of all dividends paid by a company over the past 12 months dividend by their current market caplitalzation.

Consumer Price Index is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

Cash Flow is the movement of cash in and out of a business.

Price to Earnings is the sum of all earnings accrued by a company over the past 12 months divided by their current market capitalization.

Price to Sales is the sum of all sales earned by a company over the past 12 months divided by their current market capitalization.

The chart referenced in this paper shows the returns of each representative index per factor 5 years following periods when year over year GDP was greater than or equal to 2% from 12/31/08 through 03/31/21.  The Forward Returns shown are for the factors represented by the various indexes. Forward returns do not predict or represent fund performance or the returns of any company or investment. Past performance is no guarantee of future results.

The indexes for each factor are as follows:

“Low Volatility” is represented by data from the MSCI US Minimum Volatility Index – The index is calculated by optimizing the MSCI USA Index, its parent index, in USD for the lowest absolute risk (within a given set of constraints). Historically, the index has shown lower beta and volatility characteristics relative to the MSCI USA Index.

“Growth” is represented by data from the S&P 500 Growth Index –  The S&P 500® Growth Index measures growth stocks using three factors: sales growth, the ratio of earnings change to price, and momentum.  S&P Style Indices divide the complete market capitalization of each parent index into growth and value segments.  Constituents are drawn from the S&P 500®.

“Value” is represented by data from the S&P 500 Value Index – The S&P 500® Value Index measures value stocks using three factors: the ratios of book value, earnings, and sales to price.  S&P Style Indices divide the complete market capitalization of each parent index into growth and value segments.  Constituents are drawn from the S&P 500®.

“Yield” is represented by data from the Dow Jones US Select Dividend Index – The Dow Jones U.S. Select Dividend Index aims to represent the U.S.’s leading stocks by dividend yield.

“Quality” is represented by data from the S&P 500 Quality Index – The S&P 500® Quality Index is designed to track high quality stocks in the S&P 500 by quality score, which is calculated based on return on equity, accruals ratio and financial leverage ratio.

“Size” is represented by data from the S&P 600 Index – The S&P SmallCap 600® seeks to measure the small-cap segment of the U.S. equity market. The index is designed to track companies that meet specific inclusion criteria to ensure that they are liquid and financially viable.

Indexes are unmanaged. It is not possible to invest in an index.

There can be no assurance that targeting exposure to such factors will enhance the Fund’s performance over time, and targeting exposure to those factors may detract from performance in some market environments.

There is no guarantee that a strategy of weighting and seeking high-yielding securities and sustainable dividend growth companies will produce the desired results. High-Yield securities tend to be more risky and volatile in an attempt to produce a higher yield. There is no guarantee that a company will continue to pay or increase its dividends.

Before investing you should carefully consider the Fund’s investment objectives, risks, charges, and expenses. This and other information is in the prospectus or summary prospectus. A copy may be obtained by visiting www.globalbetaetfs.com or calling (833) 933-2083. Please read the prospectus or summary prospectus carefully before investing.

Investing involves risk.  Principal loss is possible.

Distributor: Compass Distributors

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