Jacob Wackerhausen
Overview
I previously covered iShares Core High Dividend ETF (NYSEARCA:HDV) and made the mistake of giving it a Hold rating. When I initially covered it, I thought it lacked growth prospects because of the way the holdings were structured. While this still has some truth to it, I have now shifted my outlook due to the changing rate environment, utility for retirees, and stability in dividend income the fund offers. We can see that since my initial coverage, HDV has outperformed Schwab’s U.S. Dividend Equity ETF (SCHD) by a slight margin. I’ve included the S&P 500 (SPY) as a reference point, but I imagine that those looking to prioritize some income aren’t too focused on trying to outperform the S&P.
The outlook for interest rate cuts has changed dramatically from the last time I covered HDV. At the time, the market was expecting several rate cuts. However, after the latest CPI report dropped, the probability of that happening has since decreased. Inflation continues to sit higher than anticipated and the labor market remains strong with low unemployment figures. As a result, the Fed doesn’t seem to have any incentive to cut rates and are awaiting more data to roll in. Now the cuts are expected by September of 2024 or even pushed back to 2025.
So while the upside catalyst of rate cuts is removed from the picture, I believe that HDV still offers value as a dividend growth play for investors that prioritize income generation. When approaching that retirement phase of your investing journey, income generation and reliability become more important than maxing out your total return. As you depend on this income to fund your lifestyle, you’d ideally want a source of dividend income that also grows over time without you having to deploy extra capital. Well, HDV provides a sufficient level of dividend growth while remaining less volatile than peers. Lastly, the fund remains low cost, with a total expense ratio of only 0.08%.
Updated Holdings & Outlook
HDV’s strategy is simple and provides instant diversification. The ETF has high-quality US exposure to over 75 individual dividend paying companies. These companies are all screened and assessed for quality and financial health before becoming eligible for the fund. When I first covered the fund, I wasn’t too fond of the heavy weighting towards energy and healthcare stocks.
However, my outlook has shifted since both of these sectors have been beaten up and underperformed the greater market index. As a result, I believe this is an opportunity to add shares while valuations are low and capitalize from the eventual rebound. Taking a look at the energy sector (XLE) and the Healthcare sector (XLV), we can see the underperformance against the SPY.
While these two sectors have underperformed, I believe that we can eventually see a turn around. For example, the prolonged period of higher interest rates have put a damper on lots of healthcare companies because of their dependence on acquiring cheap debt to fuel research and development. As the cost of borrowing increases, there are less growth initiatives taking place right now. With this is mind, many healthcare companies also have to deal with different litigation issues that are commonplace. For example, I recently wrote an analysis on Johnson & Johnson (JNJ) where I discussed that they have ongoing lawsuits related to cough syrup recalls as well as a $700M settlement for talcum powder.
Similarly, energy companies also remain vulnerable to commodity price shifts. As market conditions become more favorable, we may see both of these sectors rebound into a bullish run. Perhaps the future interest rate cuts from the fed will serve as a catalyst for these sectors. However, I believe that the current portfolio remains well diverse and gives a lot to offer in terms of income and growth potential.
Taking a look at the updated list of holdings, we can see that energy and healthcare still hold the heaviest weighting, but the individual weight of the positions have shifted around a bit. For example, the top ten holdings now makeup over 50% of the total portfolio. Energy stocks make up 27.4% of the total portfolio. This is followed by consumer staples making up 18.5% and healthcare companies accounting for 16.2%. The top holdings are now Exxon Mobil (XOM), Chevron (CVX), and Verizon (VZ). Here are the top ten holdings:
| Ticker | Name | Sector | Weight |
|---|---|---|---|
| (XOM) | EXXON MOBIL CORP | Energy | 8.56% |
| (CVX) | CHEVRON CORP | Energy | 6.86% |
| (VZ) | VERIZON COMMUNICATIONS INC | Communication | 5.69% |
| (JNJ) | JOHNSON & JOHNSON | Health Care | 5.35% |
| (ABBV) | ABBVIE INC | Health Care | 4.95% |
| (PM) | PHILIP MORRIS INTERNATIONAL INC | Consumer Staples | 4.29% |
| (MRK) | MERCK & CO INC | Health Care | 4.16% |
| (PEP) | PEPSICO INC | Consumer Staples | 3.81% |
| (KO) | COCA-COLA | Consumer Staples | 3.81% |
| (MO) | ALTRIA GROUP INC | Consumer Staples | 3.72% |
We can see some top tier names here as part of the top ten. I like how there is a mix between clear dividend growers and high dividend payers. For example, Coca-Cola (KO) and PepsiCo (PEP) are both dividend growers with low starting yields but also dividend kings that have increased their dividend for over 50 consecutive years. On the other end of this, there are companies like Altria (MO) and Philip Morris (PM) that each have their own respectable dividend increase streak but have much higher yields. MO has a dividend yield at 9% and PM has a dividend yield of 5.4%.
With such a strong portfolio of holdings, I have no doubt that HDV will be able to provide investors with the desired level of dividend income and growth over time. This setup is perfect for the retired investor that prioritizes stability and reliability, since the holdings include companies that are dividend aristocrats and dividend kings.
Dividend
Speaking of dividends, HDV has a low starting yield but has offered sufficient growth. As of the latest declared quarterly dividend of $0.8354 per share, the current dividend yield is 3.3%. While this yield is nothing to get excited about, I believe it has the growing power to fit different needs. For example, the dividend has grown at a CAGR (compound annual growth rate) of 5% over the last decade. When you dedicate a fixed amount to HDV every single month, you have the ability to grow an income stream as well as your total position value. While the dividend payout did dip slightly in 2021 due to the pandemic era that we were in, the dividend has now grown above pre-pandemic levels.
To test this, I ran a back test using Portfolio Visualizer. This calculation assumes an initial investment of $10,000. It also assumes that dividends were reinvested every quarter, and you invest a fixed amount of $500 every single month. Starting in 2012, your annual dividend income would only be $500. Fast forward to 2023 and your dividend income would have grown to nearly $5,700 annually while your position size would now have ballooned to $172,000. You can see the results of this calculation here and play with the inputs to see what matches your needs.
Portfolio Visualizer
This shows us that when HDV is catered to on a consistent basis, we can expect dividend growth and capital appreciation. Conversely, if you were to allocate a large starting amount of capital to HDV like $1M, you would gain instant diversification and an income stream large enough to pay some of your lifestyle. Therefore, I believe HDV fits the needs of those at retirement as well as those investors that have retirement in sight within the next decade.
Downside
HDV now trades at a premium compared to its historical price range. The current price actually sits near all-time highs and therefore, may not be the best time for entry if you are expecting a market drop in the near future. If the US gets plunged into a recession of the market experiences a sharp drop in valuations, you may get stuck holding the bag while we trade sideways. On the bright side of this, you’d be collecting a safe dividend while you wait for the price to recover, but this is not ideal. However, I believe that ETFs like this work best when you dollar cost average into them every single month. When the price sits near a high, I would buy less of the stock and if the price falls, I would dollar cost average a greater sum to offset this.
In addition, the holdings still lack a sufficient exposure to the tech sector. Understandably, the tech sector is generally not known for their consistent dividend paying companies. However, tech stocks are where a lot of the growth can come from when included into the holdings. HDV does hold about 8.5% in weight to the sector, but this does not seem to be a sufficient amount to really benefit from bull markets in that sector.
We also typically see greater allocation to the financial sector since it consists of high dividend paying companies that also have the ability to generate capital appreciation. For example, SCHD has a slightly higher financial weighting and has generated higher returns as a result. While HDV does offer a less volatile experience, this may come at the cost of having to settle for lower returns from price gains.
Interest Rates
HDV has been a bit reactive to the interest rate changes over the last couple of years. We can see a bit of an inverse relationship from when rates were hiked and cut. When the effective federal funds rate was slashed to near-zero in 2020, we saw the price of HDV react to the downside, but then ultimately take off to new heights to cross that $100 per share milestone. Conversely, when rates began to rapidly get hiked in 2022, we saw the share price tumble a bit and the upward momentum was ultimately halted from there, never crossed back over the high.
My strategy here is to accumulate shares while the interest rates remain elevated. HDV is less attractive in this kind of high rate environment because investors typically flock to higher yielding assets to offset the high rates. Higher yielding assets can include different fixed income vehicles, but it can also include higher yielding assets like Business development companies, Closed End Funds, or REITs. In addition, the higher interest rate increases the cost of borrowing for these companies within HDV’s portfolio, so there are a lot less growth-based initiatives happening during this time.
My thoughts are that when interest rates finally do get cut, this will serve as a catalyst for growth. There may be an increased probability of price increases that the market dynamics become more attractive. Therefore, accumulating shares now may actually be the right move to set yourself up before these rate cuts happen. Therefore, I am upgrading my rating to a Buy.
Takeaway
iShares Core High Dividend ETF remains a solid choice for investors looking to prioritize income. Although the starting yield is low at 3.3%, the dividend growth is appealing and has proven to be able to provide a growing stream of income over time. With a dividend CAGR of 5% over the last decade, I believe that a position may be worth it.
Although the price trades near all-time highs, I think the future catalyst of interest rate cuts will help push the ETF higher. Even if rate cuts don’t happen this year, this only increases the time frame that you can accumulate shares and build your position beforehand. The new holdings are highly desired because it includes a mix of dividend growers with very long track records of growing dividends, but it also includes high-yielding companies.
