This approach to dividend stocks can diversify your S&P 500 index-fund exposure

By Philip van Doorn

Three stocks make up 20% of your S&P 500 index fund

If you have been pleased with the performance of your investment portfolio over the last decade, chances are you have at least some of your money in an S&P 500 index fund. This has enabled you to ride along with some amazing Big Tech performers while keeping expenses low.

But it might surprise you that index funds such as the $562 billion SPDR S&P 500 Index ETF Trust SPY (the first exchange-traded fund to track the U.S. large-cap benchmark index) or the $248 billion Vanguard S&P 500 ETF VOO have portfolios that are concentrated more than 19.5% to three companies: Microsoft Corp. (MSFT), Apple Inc. (AAPL) and Nvidia Corp. (NVDA).

Both SPY and VOO hold shares of all 500 companies in the S&P 500 SPX. The index itself is weighted by market capitalization, and this rewards success - all three of the stocks at the top of the weighting have been strong performers over the long term. Nvidia has soared 419% over the past three years with dividends reinvested. It now makes up 6.15% of the SPY portfolio, while it made up only 1.37% of the portfolio as of June 30, 2021, according to the fund's schedule of investments for that quarter.

For a benchmark index, the S&P 500 has become "more growthy" over recent years, according to Nick Kalivas, who heads Invesco's factor strategy for the firm's exchange-traded funds.

It is common for professional investors place stocks into growth and value camps. Growth stocks tend to be those of companies increasing their sales rapidly, with stocks trading at relatively high multiples to earnings, revenue or book value. Companies in the value camp are slower growers that tend to trade at lower multiples and are more likely to pay significant dividends to common shareholders.

One commonly cited growth benchmark is the Nasdaq 100 Index NDX, which is made up of the 100 largest companies in the full Nasdaq Composite Index. The Nasdaq 100 Index is cap-weighted and tracked by the Invesco QQQ Trust QQQ. Kalivas told MarketWatch that "the overlap between the Nasdaq 100 and the S&P 500 has moved to over 45%, from 20% 10 years ago."

During periods of declining interest rates, value stocks can benefit because of a decline in borrowing costs. This might help explain the "rotation to value" strategies that have been widely covered in the financial media this summer, amid anticipation of a cycle of cuts to the target range for the federal-funds rate. On Aug. 23, Federal Reserve Chair Jerome Powell said the time had come for lower interest rates.

There are various value-oriented index approaches you can consider if you are concerned with the concentration of the S&P 500. One approach that begins with the same benchmark is followed by the Invesco S&P 500 High Dividend Low Volatility ETF SPHD. This fund has $3.7 billion in assets and has had a net inflow of $480 million from investors since mid-July, according to Kalivas.

SPHD tracks an index of 50 stocks that is maintained by S&P Dow Jones Indices and reconstituted twice a year, on the last business days of January and July. First, the index provider identifies the 75 stocks in the S&P 500 with the highest dividend yields over the previous 12 months. This list is then cut to the 50 showing the lowest levels of price volatility during the same period. Those 50 stocks are weighted by their trailing 12-month dividend yields for the updated portfolio.

"The low-volatility screen is used with the expectation of eliminating a dividend trap," Kalivas said. A stock with a high dividend yield might have a built-in warning to investors: The high yield might reflect a low share price because a problem with the business has led some investors to avoid the stock.

"The idea is if a dividend payer has a lot of volatility, there is uncertainty for its cash flow" and its ability to maintain the dividend payout, Kalivas said.

"As a byproduct of the methodology, it gives you some exposure to value," he added.

The Invesco S&P 500 High Dividend Low Volatility ETF makes dividend distributions monthly. It quotes an SEC 30-day yield of 4.16%. The past 12 monthly distributions have totaled $1.956 a share, for a trailing distribution yield of 3.98%. If that yield doesn't seem attractive, keep in mind that bank CD rates can fall quickly once the Fed begins to cut short-term interest rates.

Here are the 10 largest holdings of SPHD:

   Company                       Ticker   Dividend yield  % of SPHD portfolio as of Aug. 28 
   Altria Group Inc.               MO              7.65%                              3.04% 
   Crown Castle Inc.              CCI              5.61%                              2.83% 
   Verizon Communications Inc.     VZ              6.45%                              2.76% 
   VICI Properties Inc.           VICI             5.02%                              2.61% 
   Bristol-Myers Squibb Co.       BMY              4.83%                              2.54% 
   AT&T Inc.                       T               5.62%                              2.47% 
   Dominion Energy Inc.            D               4.76%                              2.41% 
   Realty Income Corp.             O               5.14%                              2.38% 
   Kinder Morgan Inc. Class P     KMI              5.37%                              2.38% 
   Simon Property Group Inc.      SPG              4.95%                              2.34% 
                                                                  Sources: Invesco, FactSet 

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-Philip van Doorn

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09-03-24 0558ET

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