DJD ETF Warrants More Attention, But A Hold Feels Fitting Now (NYSEARCA:DJD)

Introduction

The Invesco Dow Jones Industrial Average Dividend ETF (NYSEARCA:DJD) is a $300m sized product that provides focused access to the dividend-paying stocks of one of the oldest equity benchmarks – the Dow.

DJD doesn’t employ any stringent barriers when selecting its stocks and this is exemplified by a requirement for just a dividend paying history over 12 months, with no supplementary gauge for sustainability. Eventually, these stocks are weighted by their indicated annual dividend yield, which is just a function of the current trailing yield.

Nonetheless, despite lacking solid enough screeners, note that DJD has done reasonably well over the past year, generating returns of 21% and also outperforming its parent index in the process.

If you’re contemplating a position in this outperformer, here are some things to note.

Stacks Up Pretty Well Against SPYD

Besides the Dow, the other major diversified equity behemoth that gets discussed a lot is the S&P500. What if one were to pursue the key dividend plays of the latter. Well, in that regard, one should be looking at the SPDR® Portfolio S&P 500® High Dividend ETF (SPYD), which also uses the indicated annual yield to ascertain the top yielders from the prime benchmark.

We think SPYD would also make for an apt comparison as it made its debut on the markets in the same year as DJD (2015). Note however that investor interest has been largely directed towards SPYD, and this is reflected in a humungous AUM of $6600m, which is 21x the level of DJD’s AUM! Meanwhile, the daily dollar volumes seen in the SPYD (roughly $50m) counter also dwarf the average volumes seen in DJD (less than $1m).

On scrutinizing the structure and the risk-adjusted performance of these two products, we don’t necessarily see why SPYD should attract considerably more interest.

Clearly, SPYD has a much wider base pool to fish from that is reflected in its reach, as it covers over 80 yielders from the S&P500, whereas DJD focuses on just 30 odd names. But as you’ll see later on, a large number of stocks doesn’t necessarily translate to better risk-adjusted returns.

From an efficiency perspective, there’s nothing to choose between the two products, as both can be picked up at identical expense ratios of 0.07%; yet, DJD appears to be the more stable offering, with an annual churn rate of 30%; this is also a function of the smaller universe it deals with. SPYD on the other hand, has the luxury of choosing from 500-odd stocks, and thus we see a much higher churn where nearly 1 in 2 stocks get turned over every year.

Admittedly, investors who don’t like products with strong concentration effects may not quite take a fancy to DJD, given its inordinately high top 10 weight which accounts for nearly two-thirds of the portfolio. In that regard, SPYD is a lot more balanced, with its top 10 contributing only 14% of the portfolio.

Where SPYD truly dazzles is perhaps its yield which has been consistently higher than DJD’s figure and is currently perched at an attractive figure of over 4% (nearly 100bps more than DJD’s).

However, do also consider the absolute return and risk-adjusted return profile of these two products, and here, it is our focus product – DJD which shines.

In the pre-pandemic era, it was a close fight between the two, as they kept trumping each other during different phases, but since the pandemic lows, DJD has consistently stayed on top. Overall, since its inception, DJD has outperformed its larger peer by 2700bps!

However, absolute returns tell only one half of the story; it’s also important to see if these products are delivering acceptable returns that commensurate with the total risk taken, or when the chips are down (during phases of downside deviation). To better understand that, we’ve looked at the Sharpe and Sortino ratios since inception, and in both scenarios note that DJD does a better job than SPYD.

Some of this could be driven in part by DJD’s heavy tilt towards Giant and large-caps (91% of the total portfolio) that have largely outperformed in the post-pandemic era (SPYD is more oriented towards mid-caps that have a 70% stake, and it also has some exposure to the riskier side of the market- small-caps which account for 7%).

Closing Thoughts – Is DJD ETF A Good Buy Now?

As suggested in the previous section, given its low-cost and stable qualities, and its ability to facilitate strong risk-adjusted returns, we think DJD deserves better attention than what it gets. However, that doesn’t mean that the product is a good buy now.

Firstly, we have some concerns over its tilt towards industrial stocks which account for the largest share of the portfolio. As things stand, beside the material sector, no other sector has been delivering weaker earnings or revenue growth.

A study from FactSet has also shown that industrial stocks have been frequently bringing up the term recession. Besides some of the internals from the latest ISM survey suggest that things could remain tough going forward. The manufacturing PMI remains in contraction territory for 5 straight months, whilst the forward-looking gauge for new orders and inventory buildup suggest that demand conditions are looking weak.

Then, as noted earlier, DJD’s prospects will also be heavily driven by how its top-10 stocks are perceived. A lot of these stocks are pursued solely for the yields they offer, but it is questionable if now is the best time to load up on them. The image below measures the weighted average current yield relative to the 4-year average, and given the price appreciation of these stocks the current figure looks rather unappealing vs. what we normally get. Granted the weighted average figure is skewed by top holding 3M Company (MMM) which has a hefty double-digit weight, but 3M’s dividend narrative appears to be on the wane following its spin-off of Solventum and the prospect of higher legal costs.

Moving over to the relative strength (RS) charts, it looks like investors who believe in the concept of mean-reversion could rotate out of DJD into the high yielders of the S&P500. DJD’s current RS ratio vs. SPYD is around 11% more than its long-term average, and runs the risk of mean-reverting.

Note also that DJD’s current P/E valuation of 16.6x is around 6% more than SPYD’s corresponding multiple.

Finally, we conclude with some thoughts on DJD’s standalone weekly chart which suggests that the price action now looks overextended after an encouraging breakout. From Nov. 2020 until May this year, the ETF had been moving sideways, we saw an attempt to break out from this range in mid-May, only for selling to re-appear. We then saw another attempt in July, and even though there was a pullback, the ETF managed to defend its breakout zone and kick on even higher. Now after 4 straight weeks of green-bodied candles, it looks like DJD could do with a pause or some retracement as the price is now trading above its upper Bollinger band (which translates to 2 standard deviations away from the 20-period moving average). As a result, we think a HOLD looks fitting now.