Are SCHD And NOBL Good Dividend Growth Investments?

SCHD and NOBL are two fairly new dividend ETFs.

The two ETFs are analyzed in a similar fashion to previous ETFs that have been examined in this
occasional series of articles.

One of them is pretty good and the other is pretty bad.

INTRODUCTION AND BACKGROUND How to start an etf

Beginning in 2012, I have examined a variety of dividend ETFs. My
perspective has been to discover whether any are as good or better
investments than portfolios carefully constructed of dividend growth stocks.
My conclusions in IOPV have generally been that the ETFs did not stand up
well to portfolios that are routinely assembled by self-directed dividend
growth investors, especially from an income perspective. Here are the
previous articles and the Fund Analytics.

Dividend ETFs Under the Microscope (NYSEARCA:DVY) (NYSEARCA:VIG)

Three More Dividend ETFs Under the Microscope (NYSEARCA:HDV) (NYSEARCA:SDY)

(NYSEARCA:VYM)

WisdomTree Dividend ETFs, Plus Overall Conclusions about Dividend ETFs(NYSEARCA:DTD)

(NYSEARCA:DHS) (NYSEARCA:DTN)

A Couple of Better Dividend Growth ETFs? (NYSEARCA:SDIV) (NYSEARCA:SPHD)

How Are WisdomTree's Dividend ETFs Doing? (NASDAQ:DGRW) (NASDAQ:DGRS) DTD DHS
DTN

Are VYM and SDY Good Dividend Growth Investments?

It is time to investigate two new entrants into the field:

Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD)

ProShares S&P Dividend Aristocrats ETF (NYSEARCA:NOBL)

BEFORE WE START
Whether you think an investment is better than another comes down to your
goals. Each individual has his or her own goals in investing. Universal
statements that one method is better than another for everyone, or that the
person with the most money at retirement "wins," are false, because they
omit the context of goals.
The previous articles' comment streams have clearly delineated the contrast
in goals. Many investors have a goal like mine, which is to build, over time,
an income stream that is sufficient for me and grows faster than inflation.
My end game is to live off that income stream, along with other sources of
income, in retirement.
Many other investors focus on total return. Their goal is to amass, over time,
the most wealth possible. Retirement is then funded by that wealth in varied
ways, including selling assets.
In modern economic writing, the total return goal is often regarded as
universal. It is presumed that every investor invests solely to become as
wealthy as possible. Comparisons among investments are made on that
metric alone, or its close cousin, risk-adjusted total returns.
So upfront, let me state that my perspective is largely based on the goal of
optimizing income over a long time frame. Many dividend growth investors
also have this as their primary goal. We recognize that total return will
happen too, but it is not our central focus.
With that background, let's get started.
SCHWAB U.S. DIVIDEND EQUITY ETF
Ticker: SCHD
Year Introduced: 2011
SEC Yield: 2.9%

Expense ratio: 0.07%. According to Morningstar, SCHD's 0.07% expense ratio

makes it the cheapest dividend ETF available.
Turnover: 13%. An ETF pays transaction costs, such as commissions, when it
buys and sells securities. A higher portfolio turnover rate may lead to higher
transaction costs and result in more taxes when shares are held in a taxable
account. These costs, which are not reflected in annual fund operating
expenses, reduce the fund's performance.
ETF Summary: Schwab states that these are the investors it believes should
be interested in SCHD:

You are seeking portfolio exposure to high dividend yielding stocks issued by U.S. companies that
have a record of consistently paying dividends and have strong relative fundamental strength based on
select financial ratios.

You want a fund that offers the potential for both current income and capital appreciation.

You are seeking to diversify your portfolio's income stream.

You are looking for a fund that combines the low turnover of indexing with an ETF vehicle that seeks
to promote tax efficiency.

You want a low-cost investment choice.

ETF Methodology: With SCHD, as with most ETFs, there are two layers of
management. In the first layer, an index provider supplies the index upon
which the fund is based. In the second layer, the ETF provider seeks to track
the index's performance. Because the fund itself does not select stocks, ETFs
like this are called "passive" investments. But do not lose sight of the fact
that stock selections are being made, and the composition and weighting of
the fund's components changes over time. That is why turnover rate is not
zero.
In SCHD's case, the underlying index is the Dow Jones U.S. Dividend 100
Index. The stated objective for this index is to measure the stock
performance of high dividend yielding U.S. companies with a record of
consistently paying dividends, selected for fundamental strength relative to
their peers, based on financial ratios.

The index contains 102 stocks, and it was first calculated on August 31,
2011. Four fundamentals-based characteristics are used to select stocks:

cash flow to total debt

return on equity

dividend yield

five-year dividend growth rate.

Stocks are also subject to screens for dividend payment consistency, size,
and liquidity. Stocks are weighted based on a modified market capitalization
approach. Individual stocks are capped at 4.5% of the index, and sectors are
capped at 25%.
According to Morningstar, the index excludes REITs, master limited
partnerships, preferred stocks and convertibles. All index-eligible stocks
must have sustained at least 10 consecutive years of dividend payments.
The index is reviewed quarterly and rebalanced annually, in March each
year. In order to keep turnover low, stocks are kept in the index as long as
their composite score remains in the top 200 of the eligible universe.
This index is the first one I have run across whose provider presents a few
dividend characteristics that are easy to find. This is an example.
(click

to

enlarge)

Although it was first calculated in 2011, Dow Jones states that estimated
back-tested total performance history is available from the end of 1998. The
back-test calculations are based on the same methodology that was in effect
when the index was officially launched. Here are the historical performance
claims made for the index based on splicing together real numbers with
back-tested results to 1998.

(click

to

enlarge)

Commendably, Dow Jones points out the inherent weaknesses of backtests:

Another limitation of back-tested hypothetical information is that generally the back-tested
calculation is prepared with the benefit of hindsight. Back-tested data reflect the application of
the index methodology and selection of index constituents in hindsight. No hypothetical record
can completely account for the impact of financial risk in actual trading. For example, there are
numerous factors related to the equitiesmarkets in general which cannot be, and have not been
accounted for in the preparation of the index information set forth, all of which can affect actual
performance.
Echoing the two-layer concept that I described above, they also discuss the
difference between an index and a fund based upon it:
The Index returns shown do not represent the results of actual trading of investible
assets/securities. S&P Dow Jones Indices LLC maintains the Index and calculates the Index
levels and performance shown or discussed, but does not manage actual assets. Index returns do
not reflect payment of any sales charges or fees an investor may pay to purchase the securities
underlying the Index or investment funds that are intended to track the performance of the Index.
The imposition of these fees and charges would cause actual and back-tested performance of the
securities/fund to be lower than the Index performance shown.
According to Morningstar, SCHD's portfolio is one of the most qualityoriented among dividend ETFs. Sixty-five percent of SCHD's holdings receive
a wide-moat rating (the highest among dividend ETFs), and only 3% have
no moat. The types of stocks in SCHD are shown by the following graphic
from Morningstar. The fund is almost completely invested in large (and
giant) capitalization stocks that fit Morningstar's definition of the value style.
All holdings are U.S.-based.

Number of stocks: 102

Fund total net assets: $2.1B
Proportion of fund in ten largest holdings: 44%
Largest holdings: This graphic shows the top 20 holdings as of September 29,
2014. Experienced dividend growth investors will recognize many names
from their own portfolios.

Distributions: Because SCHD has only been in existence since late 2011, this
Morningstar 5-year graphic shows its entire annual distribution history:

Despite its newness, I feel fairly confident that SCHD is likely to deliver
annual dividend increases of the regularity and magnitude that dividend
growth investors are accustomed to. I base this on SCHD's makeup, index
methodology, and low expense ratio.
That said, Schwab appears to manage its quarterly distributions in such a
way that quarterly dividends rise throughout the year, but then drop with
the first payment of the following year. In the following table, note how the
March payments in 2013 and 2014 fell 23% and <1%, respectively, from the
December payment that preceded it. We have seen a similar pattern in other
dividend ETFs.

The drop in March 2014 was just under 1%. (For comparison, a different
dividend index that I have studied, SDY, dropped its first payment of 2014
by 17% compared to its final payment last year.) Also, please note that this
September's most recent payment was less than June's. Such quarterly
variations are not unknown in dividend growth portfolios constructed of
individual stocks.
As you can see, if SCHD were a company, it would not qualify for David
Fish'sDividend Champions document ("CCC"). SCHD has not yet compiled a track
record of five consecutive years of distribution increases.
Total performance: Here is how Morningstar depicts SCHD's total performance
since inception. I have included SPY for comparison.
(click

to

PROSHARES S&P 500 DIVIDEND ARISTOCRATS ETF

Ticker: NOBL
Year Introduced: 2013

enlarge)

SEC Yield: 1.9% (after expense subsidy)

Expense ratio: 0.35% (after subsidy; subsidy scheduled to end 9/30/2015).
The expense ratio without the subsidy would be 0.78%.
Turnover: In ProShares' literature, I found turnover stated as 7% in one
place, while in another place it states that the 2013 turnover of the
underlying index was 17%.
ETF Summary: ProShares S&P 500 Dividend Aristocrats ETF seeks investment
results that, before fees and expenses, track the performance of the S&P
500 Dividend Aristocrats Index.
ProShares bills itself as offering the nation's largest lineup of alternative
ETFs that provide access to alternative investments. The company was
launched in 2006 and today offers over 140 alternative ETFs designed to
serve a range of investor needs, covering the spectrum from strategic to
tactical and from conservative to aggressive.
Investopedia defines alternative investments as follows:
An investment that is not one of the three traditional asset types (stocks, bonds and cash). Most
alternative investment assets are held by institutional investors or accredited, high-net-worth
individuals because of their complex nature, limited regulations and relative lack of liquidity.
Indeed, most of ProShares' ETFs are vehicles for shorting, replicating hedge
funds, and leveraging both long and short. But "alternative investments"
certainly does not apply to Dividend Aristocrat stocks, which are as
mainstream and liquid as stocks can get.
ETF Methodology: The S&P 500 Dividend Aristocrats Index, constructed and
maintained by S&P Dow Jones Indices, targets companies that are currently
members of the S&P 500, have increased dividend payments each year for
at least 25 years, and meet certain market capitalization and liquidity
requirements. The index contains a minimum of 40 stocks, which are equally
weighted, and no single sector is allowed to comprise more than 30% of the
index weight.

ProShares claims that the Dividend Aristocrats Index has, since its inception
in 2005, outperformed the S&P 500 with lower volatility. This graphic
supports those claims.

The index is rebalanced each January, April, July and October, with an
annual reconstitution during the January rebalance.
ProShares says that it follows a passive approach to investing that is
designed to track the performance of the index. (See the earlier discussion
on "passive" investing.) NOBL invests substantially all of its assets in the
stocks that make up the index, holding each security in approximately the
same proportion as its weighting in the index. Its current cash position is
just 0.2%.
This is Morningstar's style map for NOBL:

Number of stocks: 54
Fund total net assets: $259 Million. This seems surprisingly small, even after
only a year, for an ETF based on such a well-known index, when investors
have supposedly flooded into dividend stocks.
Proportion of fund in ten largest holdings: 20%
Largest holdings: This graphic shows the top 20 holdings in NOBL:

Distributions: Because NOBL is less than a year old, its distribution history is
scant, and it is too soon to draw any conclusions about it. It has made just 4
quarterly distributions in its short life, and they have varied in amount. On
an annual basis, here is what NOBL's distribution history looks like so far.

Obviously, if NOBL were a company, it would not be eligible for the CCC
document, because it is less than five years old.
Total performance: Here is Morningstar's depiction of total performance since
inception, with SPY shown for comparison.
(click

to

enlarge)

As you can see, NOBL has underperformed SPY consistently in total returns
since its inception. My guess is that its high expense ratio has something to
do with that, along with the fact that dividend-stock portfolios often
underperform SPY when the latter has a strong move up. SPY gained over
30% last year.

SUMMARY AND CONCLUSIONS

Among the dividend ETFs that I have examined, SCHD seems to come
closest to accomplishing what dividend growth investors typically do. Here
are things that I like about it.

It picks stocks based on a combination of fundamental analysis, dividend, and dividend growth
characteristics.

Most of its stocks are ones that fit most investors' definition of high quality.

Its yield (2.9%) is high enough to pass many dividend growth investors' minimum requirements.

It has an extremely low expense ratio, so most of the dividends collected by the ETF actually flow
through to the investor.

Once a stock is in the portfolio, the criteria for keeping it are relaxed. This keeps turnover (and the
expenses associated with turnover) down.

NOBL is not a good ETF, in my opinion. Its expense ratio is outrageous for
an ETF that is following a common, well-known index. Its yield of 1.9% is
the same as SPY's yield. A dividend-focused ETF should have a larger yield
than a plain-vanilla S&P 500 tracker. NOBL's yield trails its own index's yield
by a wide margin (the index's yield is 2.2%). Too much income is being
absorbed by NOBL's expense structure, and that situation will get worse next
year if NOBL terminates its subsidies of expenses as scheduled.