Taking a look at VYM

On today’s third episode of my dividend analysis series, we’re taking a look at VYM, Vanguard’s High Dividend Yield Index ETF.

In this series, we look at portfolio construction, performance and dividend growth and you can always find the other ETFs covered in this series here. The nice thing about doing these across the long run is that I’ll get more comparable data and eventually figure out the best ETFs for me to invest in. I can also do dumb rankings and crap like that later on which will be super fun.

VYM is one of the biggest dividend ETFs out there so let’s dive right into it.

VYM Details

According to Vanguard, VYM provides a convenient way to track the performance of stocks that are forecasted to have above-average yields.

You can see the high level details of VYM below and can always find the latest and greatest information and details for all of the ETFs in this series in this google spreadsheet.

VYM follows a passive strategy which keeps the expense ratio low and its large size means there should be no issue with spreads or volume.

In fact, VYM is the 2nd largest dividend ETF out there so it’ll be interesting to see if its popularity is supported by solid performance.

The great thing here is that the ETF has been around for quite some time so it has a lot of history including the 2008 recession which will give us some insight into what actually happens to dividends during a recession. All the ETFs we reviewed prior to this don’t have anywhere near that longevity so this is certainly a plus.

Based on the latest 12 months of dividends, the 3.07% yield an investor gets today is a bit lower than the 5 year average. We’ll discuss what that means later but a 3.07% yield for a high dividend yield ETF isn’t super exciting so hopefully growth is solid here.

Before we look at those things, let’s take a look at how VYM comes together.

Portfolio Construction

VYM follows a passive strategy tying itself to an index. In this case, it’s the FTSE High Dividend Yield Index which measures the investment returns of common stocks of companies characterized by high dividend yields.

In order to be included in the index, the starting point is the FTSE U.S. All Cap Index which starts with about 1827 constituents.

From there the constituents are selected on this basis;

• Removing all REITs
• Removing all stocks that are not currently paying a dividend and/or removing all stocks that are not forecast to pay dividends in the next 12 months
• Applying additional PROPRIETARY screens

Well that last part is annoying since it doesn’t really allow anyone to see what the actual screens may be. This is the first time we’ve come across something like this but maybe it’s more common in these FTSE indexes so it might show again in some other Vanguard funds.

After all these secret screens are applied, the index ends up with about 443 holdings as of today so it’s a sizable bunch of companies. I would assume that the focus is on higher yielders given the name of the ETF but hard to say with certainty given the proprietary screens.

After being set up, the index is reviewed annually and companies that cut dividends to zero will be removed on a quarterly basis.

There’s a few more situations that may impact whether a stock stays in or is removed from the index.

For example, if two constituents merge then they will stay in the index. If an existing constituent acquires a non-constituent, the company will remain in the index assuming they remain in the parent index. If an existing constituent is acquired by a non-constituent, the company shall be removed from the index and if an existing constituent has a re-org or de-merger, the newly spun-off company will stay in the index as long as it remains in the parent index.

These all seem to make sense outside of the last one unless they also check that the newly spun-off company will also pay a dividend.

While it’s hard to judge the construction of this portfolio given the nature of the data, it does yield a portfolio of familiar names.

Financials and health care are the two biggest sectors with basic materials, telecommunications and technology bringing up the rear. It’s interesting to see technology only sitting at 6.7% of the portfolio given the performance driver its been in recent years. I wonder if that will lead to some under performance here.

This is not a super top heavy portfolio with Johnson and Johnson, the biggest holding sitting at 3.27%. Exxon Mobil, JP Morgan Chase, Proctor & Gamble, Chevron, Home Depot, Pfizer, Eli Lilly, AbbVie and Coca-Cola round out the top 10 which between the lot of them make up 23.07% of the portfolio.

Much like SCHD, this doesn’t include many of the bigger tech names.

Overall, VYM’s portfolio construction is too secretive to analyze but based on its holdings it seems to focus a bit more on yield and seems to retain companies as long as they don’t cut dividends(although not many have in recent years so it’s hard to gauge that as a guarantee).

It’ll be interesting to see how the dividends have grown in recent years and more importantly how they fared back during the 2008 recession.

Dividend Growth and History

VYM is a yield focused ETFs and based on its portfolio, I wouldn’t expect explosive growth.

However, given the longevity of this ETF, it’ll be a great lesson in what happens to dividend payers in a recession. That’ll include ones that likely had a good history going into it since I assume the screens here would favor payment consistency.

We’ve got a full year of payouts all the way back to 2007 here so that’s where we’re starting.

What an interesting graph. The ETF started when the market well on its way to recovery from the 2000 crash and things were probably looking up.

That certainly was the case for the first year of growth but then it all came crashing down and the dividend didn’t recover to its 2008 highs until 2012.

It is really good to finally see what actually happens during a recession even to a dividend focused ETF like this one. I’m not sure how many more examples of this we’ll have since a lot of these ETFs are newer but its always good to have this historical context when it comes to these investments.

Even dividend ETFs will suffer and it wont only come at the expense of price. VYM did drop around 50% during that time frame so it was a combination of lost value and lower dividends for a lengthy period of time.

That’s the reality of a recession and will likely happen to all these ETFs unless they’re perfectly structured to avoid companies that cut dividends during a difficult time which is very unlikely.

The good thing is that as long as you have a long term mindset, a recovery eventually comes and you can see that in the post 2010 era where dividends ticked up and haven’t stopped. That’s a great thing for a year like 2020 as well which saw growth here and that compares well against an ETF like VOO which saw its dividends shrink in 2020.

Let’s look at how this all looks on a percentage basis.

You can see the big dip in 2009 followed by a smaller dip in 2010. Seeing your dividends drop almost 25% in the span of two years really hurts if you’re depending on that income.

It’s interesting that the S&P 500(as proxied by SPY) saw a 19.9% decrease in 2009 which isn’t that far off from VYM and SPY actually saw a 4% increase in 2010 so the difference across the two years isn’t that large. I would have expected something like VYM to hold up a lot better on this front than SPY but it really didn’t.

During turbulent times like those, that can certainly make bonds more appealing. That’s especially true as rates start rising like they are now.

Naturally a bond yield is fixed whereas this can grow as it has since 2011. However given that you can now get a 2 or 5 year bond near a 3.5% yield, that may be interesting if you’re looking for shorter term income without no risk of loss. After all, the recent market turbulence due to the higher than expected inflation reading will likely cause the fed to keep raising rates and if those bond yields keep rising then these yields will look a lot less enticing.

That’s because if a recession hits, you run the risk of a 50% price drop alongside a 25% dividend cut like we saw here during the 2008 recession and that can be downright scary. If you’re depending on these investments for income then a 4%+ yielding bond might be more appealing than a 3% yielding dividend ETF.

Still, there’s certainly no guarantee of a massive recession like the one we saw in 2008 and it is good to see that the 2020 growth is positive. So far in 2022 the growth is continuing with a 7% bump in the first 2 quarters of this year and on the bond side of things, income growth will always be 0 for the length of the bond. However, on the positive side, income growth will never be negative.

Here, the growth post recession was quite good but we’ve seen a bit of a slowdown since 2016 as we only saw one double digit growth year since then. That combined with the decreasing dividends during the recession will drive the overall growth rate down.

The overall dividend growth rate since inception for VYM is 6.07%. That’s the lowest growth rate we’ve seen so far but it’s also not fair since it’s the first ETF that existed during the 2008 recession. If we do exclude that recession and start in 2010, the bottom year, the growth rate is a bit better at 9.95% but still not all that impressive given that you’re cherry picking data and starting off at the worst point for dividends in quite some time.

If we get into direct comparisons and start in 2015, the first year of DGRO dividends, the growth rate is 6.3%. That compares poorly to 9.1% in that same time frame for DGRO and 11.9% for SCHD. It’s also only a tiny bit above the S&P 500s 5.6% growth rate in that same time frame.

Overall, the growth rate here isn’t inspiring but that’s not the goal with this ETF. However, with the yield where it is, a low growth rate will drive a less impressive yield on cost for early buyers of this ETF. I always tend to like ETFs that grow their dividends at a good clip even if they’re a bit more focused on yield because it’s easy to fall behind other similar ETFs that grow faster even if those yields start lower.

However, end of day, dividends aren’t the only thing one looks for in an investment as performance matters a lot too so let’s take a look at how VYM fares there.

Performance

Since this fund has some longevity under its belt, we’ll have to start with a comparison against the S&P 500 and other long term ETFs before diving into the comparison against the other dividend ETFs which haven’t been around as long.

To keep it simple, the data here starts in January 2007 and ends in August 2022 and shows $10,000 invested at the beginning with dividends re-invested.

VYM’s returns are a bit of a laggard here with a 1% difference which yields a pretty sizable difference in investment totals at the end of the day. The one benefit here is that the worst year is slightly better for VYM although the max drawdown is still very sizable and happened between June 2007 and February 2009 with a recovery by March 2012. That’s a long time to recover and can really show you the impact of a recession even on dividend ETFs if you haven’t seen one before.

You can see that big dip in the graph below right with a bottom right around 2009.

So what drives the difference in returns? Well given that the deviation starts around 2018, I’d wager it’s likely the lack of technology stocks in VYM. It seems like those have done really well in recent years and missing out on stocks like Apple or Microsoft seems to have impacted this fund quite a bit.

Other funds like SCHD weren’t as impacted by those missing names but perhaps those were a bit more concentrated in other names that made up the difference.

Speaking of SCHD, let’s actually take a look at how VYM compares against other dividend ETFs.

The data here will represent the same $10,000 invested with dividends re-invested and run from July 2014 to August 2022 because DGRO didn’t exist prior to that.

Overall, these are pretty disappointing returns for VYM as it lags the winner of this competition by more than 2.5%. This is a short term period but that sort of underperformance certainly doesn’t bode well.

The worst year is better than the other two but the max drawdown is still larger. Overall, I’d wager the problem here is similar to the above, an under allocation to tech which has performed well in recent years.

The annual returns tell a similar story with VYM Lagging most years but especially in 2020 where some of the holdings suffered a bit more than those in the other ETFs. It’s easy to fall behind in performance when you have a year like that one. It has done better so far in 2022 and even as of today, 9/14/22, it’s only 9.96% below its 52 week high versus SCHD which is down 13% YTD. That’s nice but it still doesn’t close the big gap above.

Dividends are another part of the story and we already talked about how VYM has lagged its two brethren but that can be seen more clearly here.

VYM actually started with the highest yield. An investor who bought in 2015 though they were getting the best yield but SCHD quickly caught up and passed it and DGRO has slowly closed the gap which started at a 22% gap and was down to 15% in 2021.

That’s one of the important things about dividends, it’s not just yield that matters but also growth because even if yield is lagging, growth can make that yield much better in the future based on our historical purchase price.

Overall, VYM is a bit lacking in performance. It does have a much richer history which is always good to see because it gives you a sense of what can happen, something that doesn’t exist with SCHD and DGRO but with the data we have to work with, VYM doesn’t quite match up to the competitors in this regard.

VYM Overview, Valuation and Scorecard

VYM is one of the biggest ETFs out there and one of the ones with the most history.

The combination of that longevity, low expense ratio and the Vanguard connection is likely one of the reasons that this is as big as it is.

Given the high yield name, I’d expect the yield to be a bit higher but I think the low growth rate has caused it to fall behind in that regard a bit in recent years. A growth rate that barely beat the S&P 500 in recent memory won’t help keep the yield high when other ETFs are growing at a much faster clip.

The performance here is a bit of a downer as well. It has lagged the S&P 500 by 100 bps since its inception and in recent years has lagged some other dividend ETFs like SCHD by more than 2.5%. That’s a pretty big gap when you compound it across a few years.

A lot of that has to do with a low allocation to technology which may or may not be a problem in the future. VYM has actually done better than all of the ETFs we looked at in 2022 as those stocks have suffered most in this recent correction and VYM was less impacted and it sits only 9.96% off its 52 week high versus 13%+ off 52 week highs for the others.

From a valuation perspective, the P/E of 14.08 as of 9/14/22 is a good deal below the S&P 500 and slightly better but not too far below the other dividend ETFs we’ve reviewed so far. You can always find the latest valuations in this spreadsheet.

Given the price movement this year and the lack of growth in recent years, VYM’s current yield of 3.07% is a bit below the 5 year average of 3.1%. That average yield is actually buoyed by 2020 as this is one ETF that rarely crests 3% outside of that year.

That’s interesting given its lack of growth but part of the appeal here is driven by its longevity and size and Vanguard name which will likely keep people invested in it for the long term.

You can see how the 3.07% compares to various historical yields below.

With that in mind, the current 3.07% yield isn’t too terrible given the yearly averages but neither is it overly attractive. One can’t be upset by this year’s price stability but for those seeking yield and looking to buy now, a lower price would make it a bit more attractive from a historical perspective.

One also has to remember that we’ve been living in a period of low rates for a while and now that bond rates are rising, some of these dividend ETFs will look a bit less enticing for those seeking income. Let’s imagine a world where bond yields start hitting 4-5% in a few months due to rising inflation and its likely that some of these ETFs will drop in value for various reasons including income investors seeking a safer(and high yielding) alternative.

The single digit growth rates in recent years aren’t doing VYM a favor in terms of its historical growth rates and that will cause it to fall behind in yield which is a problem.

Overall, VYM is a decent ETF but I’m not sure is massive AUM is fully deserved. The Vanguard name is likely the main reason for that given their huge AUM and long term nature of their investors but the longevity certainly helps. The yield and growth lags something like SCHD but this one has been around for far longer and has a more mature history so investors may not be all that willing to jump ship into something just because it outperformed for a few years.

Still, that outperformance has been pretty sizable as VYM has struggled a bit on the performance and dividend side as it lags both DGRO and SCHD in the past few years and has lagged the S&P 500 by over a % since its creation date.

Given all that, the made up scorecard reflects lower scores in the areas that matter most.

The cost structure is great given the passive nature and longevity is potentially as good as we’ll see in this series.

Dividend yield and valuation are in line with some of the others but growth and performance are a bit disappointing. If that growth continues to be poor then that yield will keep falling behind others.

The valuation might not be overly enticing right now but this ETF rarely trades below this level from a yield perspective and the P/E ratio isn’t too bad. It’s crazy looking at some of those max yields in 2020 and that was certainly an amazing time to buy some of these ETFs including VYM.

The portfolio is hard to gauge given the proprietary factors but the 400+ constituents means its not overly selective and a recession will certainly impact it as much as any other ETF as we saw in 2008. When you’ve got performance that lags the S&P 500 and a dividend growth rate that barely eclipses it, what’s the appeal besides the Vanguard name and “high” yield focus?

I do own a few shares of VYM that I’ve had for years but its lack of performance growth means I likely won’t be buying more unless the yield trends much higher. I think these income based ETFs need to start showing more growth in a rising yield environments because until they do, they’ll start showing weakness against other income options. Bonds have spent a ton of time in purgatory as yields were near 0 but now that income investors can get 2 year bonds at a 3.5% yield, that might change.

Naturally dividend ETFs will have growth while the bonds won’t but if the growth is in the low single digits, investors may start looking for better yield elsewhere. Still, the valuation here isn’t bad on a P/E basis and that still matters especially if those earnings start to grow and that trickles down to better growth on the dividend side.

Overall, I think I’d rate as the worst ETF we’ve reviewed so far but we’ll see how it fares against future reviews.

Despite that poor rating, it was amazing to see the longevity of this one and how it fared during the last recession which may give investors insight into how others would if a recession were to come.

As always thanks for reading and if you have any ETFs you’d like reviewed, let me know.

Disclosure : I am long VYM, DGRO and SCHD and maybe be long other stocks discussed in this article. This is not investment advice and I am not a financial advisor. Please talk to a professional before investing as any investments come with risk of loss, sometimes permanent. This blog is for entertainment purposes only. Returns represent past performance and are not a guarantee of future performance.