Where Do You Find Income After Investors Have Reached for Yield? An Interview with WisdomTree’s Chief Investment Strategist

Where Do You Find Income After Investors Have Reached for Yield?
An Interview with WisdomTree’s Chief Investment Strategist

By Matt Hougan

WisdomTree has been synonymous with dividend investing since it first came to market more than 10 years ago. But with many high-yielding stocks bid up to the moon, is a dividend focus still a good idea?

Luciano Siracusano, chief investment officer of WisdomTree, spoke on this topic at the recently concluded Inside ETFs conference, which took place Jan. 21-24 in Florida. I sat down with him recently to discuss his views further and learn what income-seeking investors should do in today’s challenging market.

Matt Hougan, CEO, Inside ETFs (Hougan): The premise of your session was that traditional dividend exposures may be overvalued, and investors need to look at a different approach to generating income. Is that true?

Luciano Siracusano, Chief Investment Strategist, WisdomTree (Siracusano): It depends on what you mean by “traditional dividend exposure.” For example, if you look at utilities as a sector, you could argue they're expensive because they’re trading at the high end of their 10-year P/E range.

If you're paying a higher multiple than the market, you’re buying something expensive. But the flip side of that is that the telecom sector, another traditional income-producing sector, which is trading at 15.7 times earnings, in line with its long-term average. So it really depends on what you mean by “traditional dividend exposure.”

I also think that you have to drill down into the actual ETFs people are using to get dividend exposure. There are certainly dividend ETFs out there that overweight Utilities and are trading at a high premium to the market, but there are also dividend ETFs out there like DLN [the WisdomTree U.S. LargeCap Dividend Fund] that has a price-to-earnings ratio (P/E) of 20.7, more than a 10% discount to the S&P.

Hougan: How is DLN trading at a discount when other large-cap dividend ETFs are trading at a premium?

Siracusano: Our broad-based ETFs don’t pick and choose which dividend securities to own; we own them all. In the large cap space, we own the 300 largest companies by market cap that pay dividends, and we weight them based on the total dollar value of dividends paid. By weighting using the Dividend Stream, we have the ability to rebalance the portfolio back to those locations where relative value exists once a year. Our rebalances typically increase the dividend yield of the portfolio while lowering its P/E ratio, so that's one key way we keep valuations in check.

Hougan: You panel was focused specifically on the concept of “smart beta for income.” Can you really combine the two to generate strong total returns and high income?

Siracusano: It’s almost automatic if you use the right approach. The interesting thing about weighting by the Dividend Stream is that it gives you exposure to more than one factor simultaneously. Weighting by dividends usually taps into the value factor, but it's also a very efficient way to tap into quality, and in our mid and small-cap strategies, into size. So you can get exposure to two or three factors just by focusing on the Dividend Stream. Over long holding periods, exposures to these factors have helped to explain excess returns in equity markets, both inside and outside the United States. Momentum is really the only major factor that you don't get exposure to with dividends because, by the nature of what you’re doing, you’re rebalancing away from the market.

Hougan: WisdomTree has been on the market for 10 or 11 years. How has income investing changed since you launched?

Siracusano: I think there’s a greater awareness in the market that not all yield-focused strategies are created equal, and that some sacrifice total return for yield. We believe the best dividend strategy is the one that gets you both income that's above the market and a total return that's above the market. I would say that, in the last five years, as the momentum portion of the markets has outperformed, many people have wanted to get more exposure to dividend growth. We’ve seen rising interest in dividend growth strategies that give you exposure to technology, health care and pharmaceuticals, as opposed to strategies that load up on telecom, utilities and consumer staples. That’s important right now, because those latter sectors can be especially vulnerable to rising rates.

Hougan: Why?

Siracusano: Rising rates put pressure on companies that have more debt, and utilities and telecoms typically have more leverage on their balance sheets. As a result—particularly for the highest-yielding and most leveraged stocks—they can almost act like bond proxies, where their prices fall as interest rates go up. By comparison, technology has very low leverage and often large stores of cash, so it’s protected from interest rate hikes.

Hougan: How should investors be thinking about valuation risk as they review their portfolios this year?

Siracusano: They should be looking at high valuations as a potential source of losses to their capital. You can have a market where earnings are increasing and the economy continues to do well, but the stock market can go down if P/E multiples contract. Any kind of global shift in sentiment that makes investors a little bit more risk-averse could end up contracting P/Es.

I would also add that the ETF industry had almost $500 billion in inflows last year, and a good portion of that came into low-cost beta products. When you have that much money coming in with no regard to valuation, I think you can push up multiples on the market. There’s a risk to being 100% beta 100% of the time. I would suggest people think about where they can incorporate smart beta and factors into what they’re doing, because you may get a better long-term result.

Hougan: One last question: I look at something like the WisdomTree Emerging Markets SmallCap Dividend Fund (DGS), and it’s trading at a P/E of 13. Have you seen a lot of interest in the emerging markets space?

Siracusano: I think emerging markets is a very attractive part of the global equity market. When you look back over the past 10 years, there's a big difference between U.S. returns and emerging market returns. That creates opportunities for reversion to the mean. Eventually people will take profits on some of the money that's been put to work in the U.S. in the past five to seven years, and it'll be need to be redeployed. When people redeploy capital, they typically look at asset classes that are cheap relative to their history. Right now, that’s emerging markets, and particularly, emerging markets dividends.

Source for data points: FactSet as of 12/31/2017 “Past performance is not indicative of future returns.”

Investors should carefully consider the investment objectives, risks, charges and expenses of the Funds before investing. To obtain a prospectus containing this and other important information, please call 866.909.9473, or visit WisdomTree.com to view or download a prospectus. Investors should read the prospectus carefully before investing.

There are risks associated with investing, including possible loss of principal. Funds focusing on a single country or sector and/or funds that emphasize investments in smaller companies may experience greater price volatility. Investments in emerging markets, real estate, currency, fixed income and alternative investments include additional risks. Due to the investment strategy of certain Funds, they may make higher capital gain distributions than other ETFs. Please see prospectus for discussion of risks.

WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S. only.

Luciano Siracusano is a registered representative of Foreside Fund Services, LLC.

Definitions

Dividend yield: a financial ratio that shows how much a company pays out in dividends each year relative to its share price.

Price-to-earnings (P/E) ratio: Share price divided by earnings per share. Lower numbers indicate an ability to access greater amounts of earnings per dollar invested.

Smart Beta: A term for rules-based investment strategies that don’t use conventional market-cap weightings.

Factor: Attributes that based on its fundamentals or share price behavior, are associated with higher returns

Value: Characterized by lower price levels relative to fundamentals, such as earnings or dividends.

Quality: Characterized by higher efficiency and profitability.

Momentum: Characterized by assets with recent price increase trends over time.