Inside The SuperDividend ETF: Q&A With Bruno del Ama

by on October 4, 2012 | ETFs Mentioned:

With the European Central Bank beefing up its bond repurchase program and the Federal Reserve rolling out an additional round of quantitative easing, investors are actively seeking out sources of current income amid this ultra-low interest rate environment that is expected to persist for some time. Against this backdrop, dividend-paying securities have taken on great appeal as investors are opting for reliable sources of yield in lieu of chasing after capital gains as the global economy slowly recovers. Bruno del Ama, CEO at Global X Funds, recently took time to discuss what makes the SuperDividend ETF (SDIV) attractive and unique from other offerings in the dividend space [see our Monthly Dividend ETFdb Portfolio]:

ETF Database (ETFdb): Would you explain your inspiration behind creating SDIV?

Bruno del Ama (BA): The idea came from one of our hedge fund relationships. A New York-based hedge fund manager we know very successfully managed money because they found an arbitrage opportunity within the dividend-paying universe. Companies that paid very high dividend yields (greater than 7%) were generally overlooked by investment professionals, who mostly focused on dividend stability and assumed that such high yields meant there was something wrong with the company. From this manager’s perspective, total returns, including dividends and capital gains, were what really mattered. The large amount of dividends these companies paid dramatically lowered both the risk and volatility of his fund, since the high level of cash flows received from one company could overweight the losses from another company.

ETFdb: The SuperDividend ETF tracks an equally-weighted benchmark.  What was the thought behind that part of the product design?

BA: A lot of indices are based on market capitalization weightings. We feel that with regards to high-dividend payers, there really is no point on focusing on the relative market capitalization. Our focus is on the dividends these companies pay, and how to offer our investors something that offers low risk and low volatility. All 100 companies in SDIV that pass the index screen are equally attractive to us and are equally weighted in the ETF, eliminating concentrations in any one name.

ETFdb: Given the table below, what do you think has allowed SDIV’s underlying benchmark, the Solactive Global SuperDividend Index, to post noticeably lower volatility than its closest competitors [data from Bloomberg]?

Index 30-Day Volatility 90-Day Volatility 180-Day Volatility 360-Day Volatility
Solactive Global SuperDividend Index 8.46% 11.40% 11.65% 18.97%
Mergent International Dividend Achievers Index 12.25% 15.12% 14.69% 20.93%
S&P Global Dividend Opportunities Index 16.08% 18.06% 17.47% 20.71%
Dow Jones Global Select Dividend Total Return Index 13.42% 16.29% 15.87% 19.71%
Zacks International Yield Hog Index 13.42% 16.02% 15.58% 20.93%

BA: This is key to the product. Investors have been conditioned to think that higher yield means higher risk. This is completely directional in the fixed income world – to get a higher yield in fixed income you have to take higher risk by investing in lower credit quality or longer investment maturities. When you look at the dividend space and equity securities, it is completely different.

Based on this perception of high yield as high risk, you end up having many mis-pricings in the super dividend segment, which studies have shown generates lower volatility and higher total returns than lower yielding dividend payers. We see this as having our cake and eating it too. There are a couple of reasons why this happens. The first is purely mathematical – you are getting such a high level of cash from each company that it lowers the volatility for the index and the fund. The second refers to the significant discipline high dividend-paying management teams must have to continue paying out large amounts of cash on an ongoing basis. When you are a CEO of a firm that has to make these high dividend payments, it puts a certain amount of pressure on capital use. Only the really high investment and return opportunities are pursued by managers, with the rest of the cash being returned to shareholders. This is very typical for example in Australia, where dividends are very tax efficient and institutional investors put a lot of pressure on management teams to return capital to shareholders through dividends, and as a result you see a fair amount of Australian companies represented in the SuperDividend ETF.

The fund’s diversification also plays a large role – there are 100 securities from around the world that represent many sectors. They are all equally weighted, so investors are not overexposed to one company or one segment of the market.

ETFdb: What risk measures does SDIV employ to ensure that the underlying companies can deliver attractive distributions over the long-haul? How do you protect investors from securities with unsustainable dividends?

BA: The index provider has some stability filters and looks at 12-month analyst estimates for forecasted dividends when selecting index components. We don’t claim that all companies in the SuperDividend ETF will be able to maintain their high dividend payments. But the cash from these high yield companies helps reduce the impact of any one company in the index reducing or eliminating their dividend. For example, if you have three or four companies in the index that eliminate their dividends, they only make up 3 or 4 percent of the fund and the effects are muted and outweighed by the significant cash-flow received by the rest of the high dividend paying securities. Also, the geographic and sector diversification, as well as the equal weight methodology, means investors will not be overexposed to any one segment at a time.

ETFdb: In the current economic backdrop, would you consider this as a core, or more tactical holding?

BA: We consider SDIV a core holding. Investors across the board understand the value and use of dividends in portfolios and that dividends have been the biggest percentage of total returns for investors over the last 50 years. Many value-based indices tend to have a higher proportion of dividend payers, and investors tend to understand that value over the long term outperforms growth.

Investors are also looking for alternative sources of income in the current low interest rate environment. As a result, investors generally already have some allocation to dividend payers and our expectation is that this allocation will only increase over time as baby boomers retire and continue to seek sources of income. Since many investors already hold dividend payers focused on stability with relatively low yields, we generally recommend a barbell portfolio keeping some allocation to these positions, but also include the super dividend asset class with higher yields to diversify their investments and increase their income.

Bottom Line: Looking beyond the perceived levels of higher risk associated with high-yielding securities can help investors enhance their portfolio’s current income by discovering overlooked sources of yield. In the current environment, SDIV offers upside potential as dividend-paying securities continue to take on more appeal, while at the same time providing a juicy distribution that can help reduce your portfolio’s overall volatility in these uncertain times.

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Disclosure: No positions at time of writing.