I first wrote about the Schwab US Dividend Equity ETF (New York: SCHD) A few months ago, it was called the Income Pick. In my opinion, the SCHD ETF has the best combination of historical returns, current returns, and distribution growth.
Since my article, I’ve also reviewed a number of dividend payout boxes from competing sponsors. How does SCHD stack up against these competing funds?
Using a composite scoring system, the SCHD ETF ranks among the best among high-dividend funds, with strong long-term performance and dividend growth. Although I worry about a possible recession in 2023, a high quality SCHD portfolio should outperform the market. In the worst case scenario, investors could consider hedging their SCHD position with short positions on the SPY ETF to weather the volatility.
Brief overview of the fund
First, a quick update for those new to SCHD. The Schwab US Dividend Equity ETF is Schwab’s low-cost entrant in the high-yield ETF category. The SCHD ETF strategy focuses on companies that have at least 10 years of consecutive dividend payments. The fund chooses investments based on 4 different factors: debt cash flow, return on equity, dividend yield, and 5-year earnings growth rate.
Therefore, in addition to paying a current high dividend yield, the fund also requires investments to have solid balance sheets (high debt cash flow), high profitability (ROE), and a willingness and ability to increase its dividend payout.
SCHD vs. competing funds
Since my initial article, I have developed a composite scoring system for objective comparison of funds. The scoring system ranks funds by each metric, say, one year returns, from best (1) to worst (8). The composite score then averages each bin’s score across the various scales. This methodology rewards consistency, i.e. the best scoring fund needs to outperform on multiple metrics (Figure).
Looking at SCHD’s performance relative to peer funds, we can see that it ranks very highly in terms of long-term historical returns. SCHD also has a strong Sharpe ratio, which measures returns against volatility. The historical maximum decline during the COVID crash was also one of the lowest. Finally, SCHD has a decent current yield of 3.3%, with best-in-class distribution growth rates.
On the downside, SCHD’s recent performance has been sluggish, with year-to-date returns of -6.2% and 1-year returns of -1.4%. Its volatility is also above average, although most funds cluster around the 14-15% volatility range.
Overall, the SCHD performs well in many categories, giving the box a Best Vehicle score.
How do I think about moving forward with SCHD?
It’s great to look at historical returns and see which fund has been the best performer in the “past”. However, thinking about how funds will perform in the “future” is another matter.
Currently, many economists and forecasters predict a global recession in 2023. For example, the latest reading of the Conference Board’s Recession Likelihood Index is 96%, which implies that the recession will be almost closed in the next 12 months (6 out of 6). Hit rate in the last forty years +, Figure 2).
Another indicator flashing red is the yield curve, which is most inverted in years (Fig. 3). It appears that the Fed is trying to engineer a recession to quell high price inflation.
How will the SCHD portfolio respond in a recessionary environment?
First, from Figure 1 above, we can see that in the short COVID recession, the SCHD ETF had the second smallest withdrawal of peer funds at 21.5%. So from historical performance, the SCHD ETF has shown an ability to outperform its peers
Importantly, if we analyze the composition of the SCHD portfolio, we can see that on average the SCHD portfolio has a value below the market, with a 13.4x P/E and 9.5x P/Cf vs 17.3x and 13.4x respectively for the S&P 500 (Fig. 4). While cheap stocks may continue to fall dramatically in a recession, in theory they should outperform the market and more expensive stocks.
SCHD hedge in worst case scenario
In a worst-case scenario, investors could consider hedging their SCHD position with a short in the market, for example, using the SPDR S&P 500 ETF (SPY). Since the markets peaked in December 2021, the SCHD ETF has outperformed the SPY ETF significantly, with the SCHD/SPY ratio up nearly 19%.
I believe this outperformance will continue, as SCHD’s portfolio is both higher quality (high return on equity, high debt cash flows), and cheaper (P/E). It also helps that it has a dividend yield of 3.3% versus 1.6% for the SPY ETF, which means that trading the pair has a positive carry.
Using a composite scoring system, the SCHD ETF ranks best among peer funds, with strong long-term performance and distribution growth. Although I worry about a possible recession in 2023, a high quality SCHD portfolio should outperform the market. In the worst case scenario, investors could consider hedging their SCHD position with short positions on the SPY ETF to weather the volatility.