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SDY SPDR SPOTLIGHT The Case for Dividend Growers in Volatile Markets by David B. Mazza, Head of ETF and Mutual Fund Research, Matthew Bartolini, CFA, Research Strategist, and Jared Rowley, CFA, Research Strategist, SPDR ETFs and SSGA Funds Key Takeaways A focus on companies that have consistently raised their dividends for many years, rather than focusing on yield alone, could provide a measure of safety in volatile markets. Firms with consistent dividend growth have tended to have higher-quality balance sheets and therefore may provide downside protection in turbulent markets along with some income. SPDR® S&P® Dividend ETF (SDY) is a potential solution that gives investors exposure to companies that have increased their dividend for at least 20 consecutive years. US companies with a long track record of consistently raising their dividends (“dividend growers”) have historically held up relatively better than the overall market as measured by the S&P 500® Index during market drawdowns, while also providing an income cushion. Therefore, investors worried about volatility, but who want to remain invested in equities while generating some income, can use dividend growers. This particular type of stocks can augment core portfolios with high-quality companies, or those with relatively high profitability growth, consistent earnings and low leverage.1 Quite simply, when a company is able to reliably boost its dividend for years or even decades, this may suggest it has a certain amount of financial strength and discipline. SPDR S&P Dividend ETF (SDY) is a portfolio of stocks from the S&P Composite 1500 Index that have boosted their dividends for a minimum of 20 straight years. The Case for Long-Term Dividend Growers In challenging markets, dividends can account for a greater percentage of total return. Since 1926, dividends have contributed about one-third of the total return of the S&P 500, with capital appreciation accounting for the rest (see Figure 1).2 However, dividends’ contribution to overall returns has varied through different time periods and market cycles. For example, in the range-bound US equity markets of the 1940s and 1970s, dividends represented at least 50 percent of total monthly returns.3 Figure 1: Dividend Income as a Percent of Monthly Total Return of S&P 500 % 60 53% 50% 50 39% 40 33% 28% 26% 30 14% 20 10 0 1940s 1950s 1960s 1970s 1980s 1990s 1926 to 2015 Source: S&P Dow Jones Indices, data shown is from December 31, 1925 to December 31, 2015. Past performance is not a guarantee of future results. The index returns are unmanaged and do not reflect the deduction of any fees or expenses. The index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. The Case for Dividend Growers in Volatile Markets Figure 3: More Companies are Cutting Dividends Number of Dividend Decreases 1000 800 600 400 Figure 2: Dividend Growers vs. High Dividend Payers Number of Dividend Decreases % Source: Bloomberg, as of February 29, 2016. 300 200 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 0 2000 200 1999 Yet when it comes to dividend strategies, investors face a basic decision of whether to choose companies with the highest dividend yields, or those with more sustainable dividends and relatively lower yields. During the low interest rate environment of the past several years, some investors looked beyond low-yielding bonds for income to focus on high dividend payers, which performed well in a rising equity market, although they may be riskier now. Overall earnings growth has slowed, and leverage for these high yielders is elevated. For example, SDY constituents have a debt-to-equity ratio of 187% versus 256% for the holdings of the iShares High Dividend ETF (HDV), as shown in Figure 2. — 3 Year Rolling Average 256.0 Dividend Growers Can Potentially Mitigate Risk in Volatile Markets 187.0 100 22.9 0 -100 Total Debt to Equity -1.6 SDY HDV EPS Growth 1 Year Source: S&P Dow Jones Indices, as of December 31, 2015. In what could be a volatile, low-growth market, we think investors could consider favoring dividend growers over high dividend payers. Companies that have consistently raised dividends for many years tend to have strong balance sheets and businesses. Conversely, high dividend payers with more financial leverage and lower earnings growth may be more likely to cut their dividends. A recent trend to dividend cuts has already begun (see Figure 3). These dividend cuts lower the income potential of a high dividend payer strategy. State Street Global Advisors Firms that have consistently grown dividends for at least 20 straight years – such as Procter & Gamble (PG), Johnson & Johnson (JNJ), 3M (MMM) and McDonald’s (MCD)4 – often have solid brands, business models and management. They also tend to generate relatively high cash flows and have healthy balance sheets. Their dividend yields may not be the highest, but they could be attractive to investors looking for disciplined companies that can endure difficult market and economic environments relatively well. In particular, dividend growers may provide some downside protection in falling markets. For example, in 2008, the S&P High Yield Dividend Aristocrats Index saw a total return of -23%, compared with -37% for the S&P 500.5 Since 2005, the S&P High Yield Dividend Aristocrats Index, which is made up of companies that have consistently increased their dividend 20 straight years or more, held up relatively better than the overall US market as measured by the S&P 500 during down months. Also, the drawdown protection of dividend growers was even more pronounced during the 15 worst months for the S&P 500 during that period (see Figure 4). 2 The Case for Dividend Growers in Volatile Markets Dividend growers can be used as a way to maintain exposure to the equity market with some income, while helping reduce volatility and potential drawdowns. Figure 4: Dividend Growers: Smaller Drawdowns in Volatile Markets Drawdown (%) 0 SDY: A Potential Dividend Solution -2 For investors looking for a relatively low cost, diversified portfolio of companies with a long track record of boosting dividends, SPDR S&P Dividend ETF (SDY) is a potential solution. SDY tracks the S&P High Yield Dividend Aristocrats Index, which screens for companies that have consistently increased their dividend for at least 20 consecutive years (see sidebar on index methodology). While the hurdle for index inclusion is 20 straight years of rising dividends, the index average is 35 years. Additionally, there are eight constituents with over 53 consecutive years of dividend increases (see Figure 5).7 Consider that some of these companies were increasing their dividends when JFK was President. That is consistency. -2.86 -3.68 -4 -5.76 -6 -7.57 -8 -10 S&P High Yield Dividend Aristocrats S&P High Yield Dividend Aristocrats S&P 500 S&P 500 Down Months - S&P 500 15 Worst S&P 500 Months Source: Bloomberg, State Street Global Advisors (SSGA), as of January 29, 2016. Past performance is not a guarantee of future results. The index returns are unmanaged and do not reflect the deduction of any fees or expenses. The index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income. Therefore, SDY emphasizes stability and consistency of dividends to focus on companies with higher-quality balance sheets that may provide some downside protection in turbulent markets. Because of its focus on quality balance sheets, SDY can be used to help build the core of investors’ US equity exposure in this volatile market. Dividend growers have also held up relatively better than the S&P 500 during the volatility that has gripped markets during the first two months of 2016. The High Yield Dividend Aristocrats Index had a year-to-date index price gain of 0.7 percent as of February 29, 2016 compared with a loss of 5.5 percent for the S&P 500.6 Figure 5: SDY Stocks Have Long History of Dividend Increases Number of SDY Stocks 10 8 6 4 2 0 53 48 47 45 44 43 42 41 40 39 38 36 35 34 33 32 31 30 29 28 26 25 24 23 22 Number of Years with Consecutive Dividend Increases Source: S&P Dow Jones Indices, as of December 31, 2015. State Street Global Advisors 3 The Case for Dividend Growers in Volatile Markets A Closer Look at SDY’s Benchmark: S&P High Yield Dividend Aristocrats Index • Designed to measure the performance of companies within the S&P Composite 1500 that have followed a managed-dividends policy of consistently increasing dividends every year for at least 20 years. • Weighted by indicated annual dividend yield, with constituents being re-weighted every quarter. The qualifying universe is reviewed once a year in January. • Modifications are made to stock weights to ensure no stock represents more than 4% of the index weight. • Companies included in the index come from a broad spectrum of industries. Unlike indices that focus only on high dividend yields, which are typically from the financials and utilities sectors, the “Dividend Aristocrats” are well diversified across all sectors. Source: S&P Dow Jones Indices: S&P High Yield Dividend Aristocrats Methodology. State Street Global Advisors Definitions Debt to Equity A measure of a company’s financial leverage that is calculated by dividing its total liabilities by shareholders’ equity. Drawdown Protection The degree to which an asset or investment can provide some potential defense to limit losses in a falling market. Earnings Per Share (EPS) A profitability measure that is calculated by dividing a company’s net income by the number of shares outstanding. S&P Composite 1500 Index A broad benchmark designed to track the performance of large-, mid- and small-cap US equities. S&P High Yield Dividend Aristocrats Index Measures the performance of S&P Composite 1500 constituents that have increased dividends every year for at least 20 years. SSGA, Bloomberg. As measured by Return on Equity, Debt to Equity, EPS Growth, and EPS Variability. 2 S&P High Yield Dividend Aristocrats Methodology, S&P Dow Jones Indices, November 2015. 3 Standard & Poor’s. 4 These stocks were all components of the S&P High Yield Dividend Aristocrats Index as of 1/31/2016. Source: S&P Dow Jones Indices. 5 S&P Dow Jones Indices. 6 Morningstar, as of March 1, 2016. 7 S&P Dow Jones Indices, as of January 22, 2016. 1 4 The Case for Dividend Growers in Volatile Markets ssga.com | spdrs.com For public use. State Street Global Advisors One Lincoln Street, Boston, MA 02111-2900. T: +1 866 787 2257. This material has been created for informational purposes only and does not constitute investment advice and it should not be relied on as such. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. There is no representation or warranty as to the current accuracy of, or liability for, decisions made based on this material. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This document may contain certain statements deemed to be forward-looking statements. All statements, other than historical facts, contained within this document that address activities, events or developments that SSGA expects, believes or anticipates will or may occur in the future are forward-looking statements. These statements are based on certain assumptions and analyses made by SSGA in light of its experience and perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances, many of which are detailed herein. Such statements are subject to a number of assumptions, risks, uncertainties, many of which are beyond SSGA’s control. Please note that any such statements are not guarantees of any future performance and that actual results or developments may differ materially from those projected in the forward-looking statements. Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions. Non-diversified funds that focus on a relatively small number of securities tend to be more volatile than diversified funds and the market as a whole. Passively managed funds hold a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index. All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment. The funds presented herein have different investment objectives, costs and expenses. Each fund is managed by a different investment firm, and the performance of each fund will necessarily depend on the ability of their respective managers to select portfolio investments. These differences, among others, may result in significant disparity in the funds’ portfolio assets and performance. For further information on the funds, please review their respective prospectuses. Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs. It is not possible to invest directly in an index. Index performance does not reflect charges and expenses associated with the fund or brokerage commissions associated with buying and selling a fund. Index performance is not meant to represent that of any particular fund. 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Standard & Poor’s®, S&P® and SPDR® are registered trademarks of Standard & Poor’s Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation’s financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index. Distributor: State Street Global Markets, LLC, member FINRA, SIPC, a wholly owned subsidiary of State Street Corporation. References to State Street may include State Street Corporation and its affiliates. 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