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It is often not difficult to allocate capital in bull markets. Investors seek a balance between total returns and income. Investors can make do with relatively simple investing strategies when the market is increasing every year. Investing is more difficult when the market is falling or when there are strong pockets in certain markets. Inflation makes it more difficult to invest. Income and dividend investors don’t have an easy time getting inflation adjusted income or total returns in this type of inflationary environment.
The Schwab US Dividend Equity Exchange Traded Fund is a leading dividend and income fund. (NYSEARCA:SCHD).
There are many reasons that markets are volatile right now, but the main reasons why most broader indexes are volatile over the past 2 months are geopolitical tensions as well as inflation. With the Russian invasion of Ukraine, geopolitical tensions have clearly escalated. Inflation has been a major concern for the US and other global economies since a while.
While geopolitical tensions may change, the inflationary climate we are currently in seems likely to last for some time.
Inflation has been a major problem in America’s economy. Price increases have had a significant effect on prices across the board over several years. RateSince May 2021, the inflation rate has been 5% or more every month. In February, the consumer price index was just 0.5%. ShownThe inflation rate rose to 7.9%, which is the highest since 1982. The monthly RateThe rate of inflation in the US economy has been at least 5% since May 2021 or for 9 consecutive month. Although inflation was already high before the Russian invasion, it has only exacerbated existing inflationary pressures. ConsistentlyBefore the Russian invasion of Ukraine, it was at 5% or higher.
Despite Fed comments, there are no signs inflation is likely temporary. Inflation is driven by a variety of factors, including labor shortages, large government spending, low interest rates and geopolitical tensions. These factors should continue to drive inflation for at least one year.
This Schwab US dividend Equity fund is not likely to provide inflation adjusted income or total return due to the high risk of inflation.
The fund’s first problem in the current environment is its underweight in energy and raw materials. This fund’s breakdown is as follows: 22% financials; 18% industrials; 15% technology, 15% consumer defensive and 12.5% healthcare. There are also 7% consumer cyclical and 5% communication. There are just 2% raw materials, and 2% energy.
This fund is designed to provide steady income without volatility. The fund’s holdings are significantly overweight cyclicals and energy stocks as well as raw and basic materials holdings. This fund focuses on defensive companies and companies that are not cyclical. The fund does not hold a top holding, which is a holding of at least 4%, of any cyclical or energy company or raw material stock. The current yield is just 2.95% which is nowhere near inflation adjusted income. Although the fund holds some companies with significant international operations, such as Coke or Pepsi and Pepsi, the fund is primarily focused on the US economy.
The fund is not only underweighted in inflation but also has significant holdings that include consistently underperforming stocks such a Verizon (VZ), and IBM (IBM). This holding makes up nearly 4% of the fund. IBM has consistently outperformed both the technology sector as well as the broader indexes over time. Since 2014, IBM has been among the worst performing large-cap tech stocks on the market. Verizon is another large hold of this fund. It has consistently underperformed broader indexes over five years.
This fund is not achieving its main objectives of steady income and lower volatility. This fund yields 3% at the moment, which is nowhere near inflation adjusted income. It has also been volatile at times, despite consistently outperforming the S&P500 over the past five years.
There are many exchange traded funds that are better positioned than others to offer higher income and total returns over the short-term. The Wisdomtree U.S. high dividend fund (DHS) and the Virtual Real Assets Income ETF (VRAI) are two exchange traded funds that focus on income and dividends. They are both effectively overweight inflation. These funds have a mix cyclical as well as defensive holdings and both are significantly overweight in energy stocks.
Investors are like people. Their goals can change at different times in their lives. Portfolios should be capable of delivering inflation adjusted income over the long term, and the Schwab U.S. equity dividend fund has failed to achieve that for a significant period. This fund still has a higher volatility than what investors would expect from a fund with a high percentage of defensive companies. Past performance is not always indicative of future performance. However, with inflation likely to persist in the U.S. for some time, there will be better positioned funds for investors looking to adjust income and total returns.
