ETFs have opened up the doors to investment strategies that were simply out-of-reach for most not too long ago. One example of democratization in the investment landscape is the introduction of exchange-traded products that allow for investors to potentially generate returns uncorrelated to the broad equity market.
ETF Database (ETFdb): What was your firm’s motivation to enter the ETF industry and launch the DIVS ETF?
Ryan Ballantyne (RB): Reality Shares was started by a former Morgan Stanley financial advisor, Eric Ervin, who was often frustrated at the disconnect between the reality of a company’s performance and its stock price. Seemingly sound and fundamentally solid companies were often punished and held hostage to market nuances, noise and news events that often had nothing to do with the corporation and should therefore not have impacted the share prices of these companies.
Frustrated by this disconnect, Reality Shares was created in order to deliver investment vehicles that could remove the market noise and focus solely on fundamental aspects of companies. The creation of our first ETF (ticker: DIVY) was born primarily to address this concept of isolating a fundamental and tangible aspect of the business from its share price, more so than the desire to launch an ETF.
However, the proliferation and acceptance of ETFs among the investing public and the liquidity and transparency offered by an ETF wrapper was a perfect vehicle to introduce our strategy of isolated dividend growth. Additionally, ETFs are becoming both a strategic and tactical way of investing thematically and this is where a lot of innovation is occurring.
One such fundamental disconnect we observed was the difference between the dividend growth of the market and its respective total return. While it would seem that dividends are highly correlated to the market, this is not necessarily always the case, as seen below:
At Reality Shares, we attempt to minimize marketplace noise and distraction by isolating dividend growth from stock price performance.
ETFdb: What is your overarching philosophy with regard to DIVY? Please elaborate on what this ETF is and isn’t designed to do.
RB: We believe DIVY represents a paradigm shift in how investors will think about generating returns based on genuine underlying value creation. The rules-based strategies employed by DIVY are designed to provide long-term results based upon expected dividend payments, which historically have increased over time in large cap stocks.
Unlike traditional dividend focused products, DIVY does not seek to produce returns based on changes in the stock market price of dividend-paying securities and does not generate dividend income. Rather, DIVY seeks to produce returns based on increases in the expected dividend values of these securities, independent of price performance and dividend yield.
ETFdb: What is the objective of the fund? Please walk us through the portfolio construction process.
RB: The investment objective of the Fund is to produce long-term capital appreciation. Under normal circumstances, we generally invest in a series of listed index option contracts that, when combined together, are designed to eliminate the effect of changes in the trading prices of the large cap securities and the effect of interest rate changes on the prices of the option contracts. As a result, the value of the Fund’s option portfolio is designed to change based primarily on changes in the expected dividend values as reflected in the option prices. These option combinations are designed to reflect expected dividend values and eliminate the Fund’s exposure to changes in the trading prices of the large cap securities.
The portfolio is constructed using a rules based methodology (see image below) in order to arrive at the optimal exposure to both the S&P 500 and Nasdaq 100 indexes. Keeping in mind that the portfolio does not invest in the individual constituents of the indexes. Instead, the portfolio is exposed to the dividend growth rate of all the constituents in both indexes.
In other words, we do not pick individual stocks. The portfolio is exposed to the growth rate of dividends for both indexes.
ETFdb: Who is DIVY targeted towards? Why does it make sense for them to utilize this strategy in the ETF wrapper?
RB: DIVY can meet specific and diverse investment objectives in a liquid and cost-effective ETF wrapper. The Fund offers the following potential diversification benefits:
- Potential return enhancer – Investors looking for potential mitigation against rising interest rates may want to allocate a portion of their portfolio to DIVY
- Potential risk reducer – Investors seeking to potentially preserve capital in volatile or down markets may want to allocate a portion of their portfolio to DIVY
- Potential inflation hedge – Dividends perform particularly well in inflationary environments.
We are offering this innovative investment choice to investors seeking potential long-term returns that are not directly correlated to broad equity market or fixed income price movements.
Be sure to see ETFdb’s list of Alternatives ETFs.
ETFdb: How does DIVY differentiate itself from other alternative-strategy funds? Would you consider this a core, or more tactical, holding?
RB: DIVY, unlike traditional dividend focused products does not seek to produce returns based on changes in the stock market price of dividend-paying securities and does not generate dividend income. Rather, DIVY seeks to produce returns based on increases in the expected dividend values of these securities, independent of price performance and dividend yield. This is a very important distinction as other dividend strategies merely select dividend paying stocks and weight them according to their dividend footprint.
In the end, however, these products still deliver market returns because after all, they are just baskets of stocks weighted differently.
DIVY therefore can draw from both fixed income and equity allocations as a core position. One might also choose to utilize DIVY as a tactical vehicle when there is concern about valuations or macro economic events that could send equities zigging and zagging.
The Bottom Line
Investors have no shortage of choices to pick from when shopping for a dividend-focused product; however, the reality is that these equity funds are all exposed to various market risks that can bring down the value of even the most fundamentally-sound dividend stocks.
As such, anyone looking to gain exposure to the dividend growth of large cap stocks, without being exposed to fluctuations in stock price, should take a closer look at the recently launched DIVS ETF (DIVY). This ETF is truly unique in that it offers investors the potential to tap into returns that are not directly correlated to broad equity markets or fixed income price movements.
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Disclosure: No positions at time of writing.