The Vanguard High Dividend Yield Index Fund ETF (NYSEARCA:VYM) and the Schwab U.S. Dividend Equity ETF (SCHD) are two of the most popular dividend ETFs, having amassed $67.87 billion and $55.36 billion in assets under management (AUM). At a point, I wasn’t thrilled with being invested in VYM, but I didn’t exit the position because I didn’t want to become too heavily weighted toward SCHD. I am certainly glad I didn’t just go off trailing data in my decision because VYM has been outpacing SCHD over the past year from a capital appreciation perspective. I am bullish on VYM because it allows investors to own a basket of income-producing securities with strong track records of dividend growth. There are many different income-focused ETFs and CEFs, and VYM is one of the cornerstones of my income-producing portfolio. I believe that VYM can continue higher throughout 2024 and deliver future annualized growth that will allow investors who are reinvesting the dividends to harness the powers of compounding. If you’re looking for an income-focused ETF without an option overlay strategy, VYM has been solid over the past year.
Following up on my previous article about VYM
I recently became bullish again on VYM, as shares were no longer stagnant. Since my last article, published on January 3rd (can be read here) shares have appreciated by 6.13% compared to the S&P 500, climbing by 9.82%. When the Q1 dividend is taken into consideration, VYM’s total return is 6.73%. In that article, I discussed how VYM had exceeded my 2023 expectations and why I was keeping VYM in my income-producing portfolio after going through a period where I debated exiting the position. I am following up with a new article to discuss why I feel shares can continue to rally and why I have found a newfound excitement about being invested in VYM.
Risks to investing in VYM
VYM seeks to track the performance of the FTSE High Dividend Yield Index, which is comprised of companies with high dividend yields. VYM is a dividend index fund that invests in most companies within the FTSE Dividend Yield Index, if not all of them. There are two main risks in investing in VYM, which consist of market and investment style risk. If we enter into a bear market or a flat market or if we get a retracement, VYM will likely follow the direction of the market. VYM doesn’t implement a strategy to mitigate downward trends, and many of its holdings can be found in an S&P 500 index fund. The next major risk is underperforming the broad market due to its investment style. The SPDR S&P 500 ETF Trust (SPY) has a 30.57% allocation to technology, while 6 of the Magnificent Seven can be found within its top-10 holdings. When looking at the Invesco QQQ Trust ETF (QQQ) there is a 49.85% allocation toward technology, and all the Magnificent Seven are found within its top-10 holdings. Due to its focus on companies that generate large dividends, VYM faces investment-style risk as there could be a significant opportunity cost if tech continues to fuel a bull market rally.
VYM continues to outshine similar ETFs from a capital appreciation perspective
Some of the more popular traditional dividend-focused ETFs are VYM, SCHD, SPDR Portfolio S&P 500 High Dividend ETF (SPYD), iShares Core High Dividend ETF (HDV), Invesco S&P 500 High Dividend Low Volatility ETF (SPHD), and the iShares Select Dividend ETF (DVY). Over the past year, VYM has appreciated by 12.13%, while SCHD, HDV, SPYD, SPHD, and DVY have gained between 2.99% – 8.2%. There was a period in time where VYM had trailed many of these funds from a capital appreciation perspective, but since bottoming out at $98.40 in October, shares of VYM have climbed 21.07% and are tittering around their 52-week highs. Over the past 5 months, this has caused VYM’s dividend yield to decline from 3.48% to 2.87% as shares continued to appreciate. Investors who had invested in VYM earlier in the year had locked in their yield on cost and are still generating the same dividend income, the yield is simply less due to the higher share price. For many investors, this is welcomed as VYM generates an enticing blend of appreciation and yield.
VYM and SCHD are the two powerhouses in the traditional dividend ETF space. I don’t compare them to the JPMorgan Equity Premium ETF (JEPI), or the Global X Nasdaq 100 Covered Call ETF (QYLD) because they don’t implement an option overlay strategy to generate additional yield. Stripping away the other funds I compare VYM and SCHD to, VYM is gaining a lot of ground on SCHD. Over the past year, VYM has generated an additional 3.93% of capital appreciation compared to SCHD, while in 2024, VYM has grown by an additional 2.7%. The roles used to be reversed, and while SCHD is still up 47.73% over the past 5 years compared to VYM’s 36.1%, VYM’s portfolio has generated more Alpha during the recent bull market. VYM has an 11.15% allocation toward technology holdings, whereas SCHD’s allocation sits at 8.6%. If technology continues to provide fuel to the latest bull run during Q1 earnings, the VYM could certainly outpace SCHD and continue higher in 2024.
Why I think VYM continues higher and will continue to grow its dividend
There are a lot of things working in the market’s favor. The next FOMC meeting is in roughly 20 days, and CME Group is projecting that there is a 56.2% chance that the first-rate cut will occur at the June meeting, while there is an 85.5% chance that rates will finish the year under 5% for the year. The most likely scenario is that rates finish between 450-475 bps, as there is a 33.7% chance this will occur. There is $6.36 trillion sitting on the sidelines in money market accounts, which can still yield up to 5.3%, but as the Fed starts to cut rates, financial institutions will start to lower the rates they are paying on deposits. As the risk-free rate of return starts to decline, there will be less of a reason to remain in risk-free assets as a proxy to generate income. People will still be using a CD ladder or a money market account for cash they want to keep on hand, but the T-bill and chill movement will likely dissipate. My prediction is that once the Fed pivots, we will see many investors try to front-run the remaining rate cuts and reallocate capital from the sidelines into income-producing securities. This should be directly and indirectly bullish for VYM as they should capture some of the capital flowing indirectly, while its underlying assets get a boost from increased volume.
When I look at the top-10 holdings for VYM, they are what I would consider top-tier dividend companies. I went through their forward earnings estimates, and as a group, they look inexpensive. The top-10 holdings are trading at 18.33 times 2024 earnings, and trading for 15.42 times 2026 earnings. These companies are expected to grow their earnings by 17.72% over the next two years. The amount of earnings growth on the horizon combined with a forward earnings multiple that is under 20 on average could cause the holdings within VYM’s portfolio to rally if we get a strong earnings season in Q1.
As capital moves back into the market, some will want to invest in income-producing assets. Rather than picking individual entities, some investors would rather purchase a basket of securities through an ETF. VYM currently has a yield of 2.87% as it pays an annualized dividend of $3.42 per share. VYM has increased its dividend annually for the past 13 years, and over the past 5-years it has a 5.22% growth rate. Looking at the top-10 holdings again, their average dividend yield is 2.61%, but their dividend growth is the key. Collectively, they average 29.8 years of annualized dividend growth with a 5-year growth rate of 7.87%. This is very interesting as the largest holdings within VYM’s portfolio have a long history of dividend growth, indicating that increasing their dividends will fuel VYM to continue its annual dividend increases.
Conclusion
VYM continues to surprise me, as it has outpaced SCHD over the past year and has had a better start to 2024. I remain bullish on VYM as it has the potential to continue higher during earnings season and throughout 2024. I think a lot of money will get reallocated into the capital markets when the Fed finally pivots. When that happens, I think companies such as JPMorgan Chase (JPM) and AbbVie (ABBV) will catch a bid as they trade for low P/E valuations, have forward growth on their side, and pay a modest dividend. This would be bullish for VYM, and I think a portion of capital reentering the market will gravitate toward income-producing ETFs, especially VYM. For investors looking for a combination of capital appreciation and modest dividend yield, VYM has been a solid pick. I think VYM will continue higher and continue to increase the dividend annually.