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 quality-

oriented 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

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 enlarge)

PROSHARES S&P 500 DIVIDEND ARISTOCRATS ETF

Ticker: NOBL

Year Introduced: 2013

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.