Best of Both Worlds: High Yield Income Potential with Aristocratic Quality Sure Dividend

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Best of Both Worlds: High Yield Income Potential with Aristocratic Quality


This is a guest contribution by Taylor Krystkowiak, Vice President of Product Management at Cboe Vest.  Cboe Vest is the creator of Target Outcome Investments, which strive to buffer losses, amplify gains, or provide consistent income to a diverse spectrum of investors. The first of these leading-edge investments, Cboe Vest’s flagship Buffer Protect Strategy, was introduced in 2013.

Difficult Dynamics for Dividends

2020 proved to be a difficult year for dividends.  Buckling under the unprecedented pressures of the pandemic, traditional dividend-oriented sectors struggled over the past year; Energy, Financials, Real Estate, and Utilities all logged negative annual returns.  Energy suffered significantly as oil prices crashed, Real Estate revenues were strained by declining demand for office/retail space, and Financials/Utilities were sapped by historic unemployment spikes, business disruptions, and ongoing economic uncertainty.  On the other hand, the valuation of the S&P 500 (see footnote 1) as a whole (as well as the vast majority of its individual sectors) rose significantly as price-to-earnings (P/E) (see footnote 2) multiples expanded to historic highs relative to long-term averages.  Meanwhile, interest rates and bond yields fell to all-time lows in the wake of accommodative monetary policy, a major factor underpinning this expansion in equity valuations.  The yield on the benchmark 10-year Treasury (1.08%) is near its all-time low, while the P/E ratio of the S&P 500 (30.70) is at an all-time high (see Figure 1).

These dual dynamics have driven dividend yields to historic lows and present a unique challenge to income-oriented investors.  The current dividend yield on the S&P 500 is 1.58%, its lowest point in over 15 years.

Figure 1.

The New Normal

Navigating the New Normal

In this new market environment, dividend-oriented investors are seemingly faced with a difficult decision: preserve yield at the expense of performance, or preserve performance at the expense of yield.  Yet, a certain class of equities (aptly named the “Dividend Aristocrats”) has defied this prevailing dynamic.

In order to be considered a “Dividend Aristocrat,” a company must have increased its dividend every year for the last 25 consecutive years, a designation earned by only 65 companies in the S&P 500.  Given that these companies have survived many other major storms that have swept the stock market over the past quarter century or more, it is unsurprising that this tried-and-true class of “aristocrats” proved to be uniquely resilient to the pressures posed by the pandemic.  Simply put, they were the best suited to navigate this new normal, a reality reflected by both their performance and dividend growth.  Over the course of 2020, the S&P 500 Dividend Aristocrats Index (see footnote 3) was one of the only major indices/sectors that both increased its yield and posted positive price performance (see Figure 2). 

Figure 2.

2020 Yield Growth & Performance

Driving Dividends with Derivatives

Yet, the current yield from the Dividend Aristocrats alone may be insufficient for some income-oriented investors.  Traditionally, investors seeking the highest incomes have had to sacrifice quality or assume more risk in order to obtain higher yields.  Currently, the only major indices/sectors that provide yields exceeding 4% are Energy, high-dividend equities, and high-yield bonds (i.e., sub-investment grade), all of which logged negative returns in 2020 and require investors to assume additional risk relative to higher quality assets (see Figures 2 and 4).

However, an alternative (and often under-utilized) option to increase income without necessarily sacrificing quality is leveraging the potential benefits of derivatives.  Writing (i.e., selling) call options (see footnote 4) on a percentage of portfolio assets can be an effective way to boost income without compromising asset quality.  Cboe Vest has utilized this strategy in its S&P 500 Dividend Aristocrats Target Income ETF (KNG), one of the few exchange-traded funds (ETFs) that allow investors access to the Dividend Aristocrats Index.  The strategy seeks to obtain a total income target that is 3% above the annual dividend yield of the S&P 500 Index.  The fund achieves this goal by not only holding stocks from the Dividend Aristocrats Index and collecting their dividends, but also writing call options on a percentage of the portfolio (see Figure 3).

Figure 3.  Dividend Aristocrats Target Income Strategy

Total Return Objective

The net effect is a higher annualized yield than can be obtained purely through the Dividend Aristocrats Index; the current annualized yield of KNG is 4.29%, which is 1.66% higher than the current 2.63% yield of the Dividend Aristocrats Index (see Figure 4).  As a result, KNG offers investors a yield that rivals even the highest yields provided by Energy (5.84%), high-dividend equities (4.90%), and high-yield bonds (4.89%), while maintaining exposure to the higher-quality and positively-performing stocks that comprise the Dividend Aristocrats Index.  In short, the strategy offers an often elusive synergy between yield, quality, and performance, which may prove to be a competitive solution for income-oriented investors.

Figure 4.

Current Yield On Major Indices

Note:  Performance data quoted represents past performance. The ETF’s past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost. Current performance of the ETF may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month end by calling 855-505-VEST (8378).

A Strategic Solution for the Income Investor

As shown by its performance and yield, the Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF has not only persevered but prevailed over the pressures posed by the pandemic.  The fund continues to offer investors the opportunity to gain exposure to both high-quality equity growth as well as a highly competitive yield, and the diversified nature of its underlying Dividend Aristocrats Index mitigates single-stock and/or sector risk.

In short, the strategy has proven to be a sound solution that has succeeded in both stormy and steady conditions alike, which may make it a worthwhile addition to the portfolio of any income-oriented investor.

Definitions, Risk Factors, & Legal Information

Investors should consider the investment objectives, risks, charges and expenses carefully before investing. This and other information is contained in the Fund’s prospectus, which may be obtained via the link below or by calling 855-505-VEST (8378). Please read the prospectus carefully before investing.

Must be preceded or accompanied by a current prospectus.

Distributed by Quasar Distributors, LLC.

Definitions and Key Terms:

Footnote 1:  S&P 500 Index: The Standard & Poor’s (S&P) 500 Index, is a market-capitalization-weighted index of the 500 largest publicly-traded companies in the US.  The index includes 500 leading companies and covers approximately 80% of available market capitalization.

Footnote 2:  Price-to-Earnings (P/E) Ratio: The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).

Footnote 3:  S&P 500 Dividend Aristocrats Index: S&P 500 Dividend Aristocrats measure the performance of S&P 500 companies that have increased dividends every year for the last 25 consecutive years. The Index treats each constituent as a distinct investment opportunity without regard to its size by equally weighting each company.

Footnote 4:  Covered Call Option: A covered call is an options strategy whereby an investor holds a long position in a stock and sells (also referred to as “writes”) call options on that same stock in an attempt to generate increased income from the stock. A covered call is also known as a “buy-write.”

Risk Factors:

To the extent the Fund invests more heavily in particular sectors of the economy, the Fund’s performance may be more sensitive to developments that significantly affect those sectors. The Fund is non-diversified and may concentrate its assets in fewer holdings than a diversified fund. Therefore, the Fund is more exposed to individual stock volatility. The Fund’s emphasis on dividend-paying stocks could fall out of favor, or companies could reduce or eliminate dividends. Derivatives, such as the options in which the Fund invests, can be volatile and involve various types and degrees of risks, depending upon the characteristics of a particular derivative. Derivatives may entail investment exposures that are greater than their cost would suggest, meaning that a small investment in a derivative could have a substantial impact on the performance of the Fund. Writing call options are speculative activities and entail greater-than-ordinary investment risks. The Fund’s use of derivatives, such as call options, can lead to losses because of adverse movements in the price or value of the underlying stock, which may be magnified by certain features of the options. These risks are heightened when the Fund’s portfolio managers use options to enhance the Fund’s return or as a substitute for a position or security. When selling a call option, the Fund will receive a premium; however, this premium may not be enough to offset a loss incurred by the Fund if the price of the underlying stock is above the strike price by an amount equal to or greater than the premium. The Fund’s use of options may reduce the Fund’s ability to profit from increases in the value of the underlying stock(s). The Fund may “turn over” some or all of its covered calls as frequently as weekly, and higher portfolio turnover may result in the Fund paying higher levels of transaction costs and generating greater tax liabilities for shareholders The Fund’s covered call strategy may limit its ability to distribute dividends eligible for treatment as qualified dividend income and to distribute dividends eligible for the dividends- received deduction for corporate shareholders. For these reasons, a significant portion of income received from the Fund may be subject to tax at effective tax rates that are higher than the rates that would apply if the Fund were to engage in a different investment strategy. As with all index funds, the performance of the Fund and its Index may differ from each other for a variety of reasons. For example, the Fund incurs operating expenses and portfolio transaction costs not incurred by the Index. In addition, the Fund may not be fully invested in the securities of the Index at all times or may hold securities not included in the Index. There can be no guarantee that the Index or Fund will be successful in achieving the objective. The total return performance of the Index and Fund could be negative, even when the Fund achieves its objectives.

Read the “Principal Risk” section of the prospectus for a complete listing of fund-specific risks.

Target Income ETF is a trademark of Cboe Vest Financial LLC. Target Outcome Investments® is a registered trademark of Cboe Vest Financial., LLC.

About the Investment Advisor

Cboe Vest Financial LLC is a wholly owned subsidiary of Cboe Vest Group Inc. Cboe Vest offers institutional-quality Target Outcome InvestmentsTM built on the backbone of its unique investment philosophy—that strive to buffer losses, amplify gains or provide consistent income—to a diverse spectrum of investors.  Distributed by Quasar Distributors, LLC.

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