Problem with Dividend Aristocrats Index Construction

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imak
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Problem with Dividend Aristocrats Index Construction

Post by imak » Fri Feb 14, 2020 11:41 am

Encountered this interesting piece from Matt Levine's Bloomberg article, related to SDY ETF, which tracks S&P High Yield Dividend Aristocrats Index. Index construction rules lead to a concentrated position of about 40% in only two stocks & these two stocks had dropping market cap, resulting in falling out of index.

From the article published on 17 Jan 2020:

"
Weird indexing
We talked yesterday about an unusual exchange-traded fund called SDY, the SPDR S&P Dividend ETF. This is a passive ETF that owns large-cap stocks with high dividend yields; it chooses stocks from a large-cap index, and weights those stocks by dividend yield. This has a weird effect: As a stock’s price goes down, its dividend yield, arithmetically, goes up, since the dividend yield is just the dividend divided by the price. So SDY buys more of a stock as it goes down. But if a stock goes down too far, its market capitalization will be too small for the large-cap index, and it will be booted from the index, which means that SDY will have to sell its entire position.[1] Which got bigger on the way down. This is apparently about to happen to SDY with two stocks—Tanger Factory Outlet Centers Inc. and Meredith Corp.—and it is awkward. SDY has built up big stakes in those companies, about 22% and 18% of the shares outstanding, respectively, and now it will have to dump them all at once.

You would expect this huge forced selling to be bad for the stocks’ prices, and for SDY’s performance. But there is a silver lining. There is a lot of short interest in Tanger stock: A lot of people were betting against it, by borrowing stock and selling it short. Often these people were borrowing the stock from index funds: Index funds tend to be enthusiastic stock lenders, because they are stable owners of big blocks of stock and can boost returns slightly for their investors by lending the stock out to short sellers and charging a fee. This means that large index ownership of a company can cause increased short selling of that company: If there are lots of shares available to borrow cheaply, then more investors might be tempted to bet against the company by selling short. “Short interest in SKT [Tanger’s ticker symbol] has been exacerbated by the stock’s above-average ownership among passive holders, who are among the largest lenders of shares at relatively lower costs to the borrowers,” research analysts at Citi wrote in a note to clients last week.
"
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sycamore
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Re: Problem with Dividend Aristocrats Index Construction

Post by sycamore » Fri Feb 14, 2020 12:46 pm

imak wrote:
Fri Feb 14, 2020 11:41 am
Encountered this interesting piece from Matt Levine's Bloomberg article, related to SDY ETF, which tracks S&P High Yield Dividend Aristocrats Index. Index construction rules lead to a concentrated position of about 40% in only two stocks & these two stocks had dropping market cap, resulting in falling out of index.
...
Thanks for posting. How an index is constructed can make for some weirdness, as the article mentioned. I don't hold SDY myself but I do hold some other funds that tilt to various parts of the market. Your post is a good reminder that one should understand what one invests in before buying.

One minor nit: in your quote above, I think the 40% is not how much of SDY was in two companies, Tanger and Meredith. Rather, SDY held 22% of Tanger's shares and 18% of Meredith's shares. As you quoted: "SDY has built up big stakes in those companies, about 22% and 18% of the shares outstanding, respectively..." I suspect the Tanger and Meredith positions within SDY were probably around 1 or 2% at most. If SDY had to sell off 40% of its underlying holdings... whoa.

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Re: Problem with Dividend Aristocrats Index Construction

Post by nisiprius » Fri Feb 14, 2020 1:11 pm

Running with sycamore's point...

SSGA SDY web page

If I download the semiannual report from June 30, 2019, I see:

Net assets: 18,698,028,758
Tanger Factory Outlet Centers, Inc. REIT: 198,744,845
Meredith Corp: 185,979,466

So I calculate Tanger and Meredith to have been 1.07% and 0.99% of the portfolio on 6/30/2019.

I looked at the article and it just seems like the usual index bashing. Yes, there are bound to be problems and weird stuff at the margins of any index or index fund that doesn't try to include the whole market, because of weird stuff happening with stocks that are on the edge of an artificial bright-line boundary. Like whole countries dropping in and out of emerging markets funds.

ADDED: But, hey, wait a minute. I thought a fund had to warn you that it was not "diversified" if it held more than 10% of the outstanding shares of any company. Is SDY billed as a non-diversified fund? What does SSGA say?

Answer: The prospectus says, see page 106,
Non-Diversification Risk: As a “non-diversified” fund, the Fund may hold a smaller number of portfolio securities than many other funds. To the extent the Fund invests in a relatively small number of issuers, a decline in the market value of a particular security held by the Fund may affect its value more than if it invested in a larger number of issuers. The value of Fund Shares may be more volatile than the values of shares of more diversified funds. The Fund may become diversified for periods of time solely as a result of changes in the composition of the Index (e.g., changes in weightings of one or more component securities).
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Northern Flicker
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Re: Problem with Dividend Aristocrats Index Construction

Post by Northern Flicker » Fri Feb 14, 2020 2:17 pm

There are various anomalies with “indices” that are really closet active management. The dividend aristocrat fund is really an active fund that outsources portfolio management to S&P. With the rule for inclusion being public, there would be concern about front-running of changes, although there may not be enough assets tracking the index to be a target. SDY also has not done a good job of managing capital gains, unsurprisingly.
Risk provides no guarantee of return.

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DG99999
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Re: Problem with Dividend Aristocrats Index Construction

Post by DG99999 » Sat Feb 15, 2020 9:26 am

imak wrote:
Fri Feb 14, 2020 11:41 am
Encountered this interesting piece from Matt Levine's Bloomberg article, related to SDY ETF, which tracks S&P High Yield Dividend Aristocrats Index. Index construction rules lead to a concentrated position of about 40% in only two stocks & these two stocks had dropping market cap, resulting in falling out of index.

From the article published on 17 Jan 2020:

"
. . . and it is awkward. SDY has built up big stakes in those companies, about 22% and 18% of the shares outstanding, respectively, and now it will have to dump them all at once.
"
The statement appears to refer to the percentage of each company's total shares that the fund holds, the statement does not appear to be referring to the composition of the fund (see Nisiprius above).
I am not a financial professional. My posts are only my opinion on the topic. You need to do your own due diligence and consult with a professional when addressing your financial questions.

ARoseByAnyOtherName
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Re: Problem with Dividend Aristocrats Index Construction

Post by ARoseByAnyOtherName » Sun Feb 16, 2020 7:33 am

nisiprius wrote:
Fri Feb 14, 2020 1:11 pm
I looked at the article and it just seems like the usual index bashing. Yes, there are bound to be problems and weird stuff at the margins of any index or index fund that doesn't try to include the whole market, because of weird stuff happening with stocks that are on the edge of an artificial bright-line boundary. Like whole countries dropping in and out of emerging markets funds.
Matt Levine has been writing for (at least a few) years about index funds, mainly along the lines of “should index funds be illegal?” I wouldn’t call it bashing per se, not any more than I could reduce any of his writing down to one simple word.

I find most of his writing to be interesting, well-reasoned, sometimes though-provoking, and usually humorous. A lot of it is precisely about the weird stuff at the margins. His writing about index funds isn’t an exception.

Full disclosure, I am a fan of both index funds and Matt Levine’s writing. :D

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imak
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Re: Problem with Dividend Aristocrats Index Construction

Post by imak » Mon Feb 17, 2020 11:55 am

Thanks sycamore and nisiprius for pointing out the correct concentration of these two companies in index. I misunderstood that to be positions weighting in the index.
Asset Allocation: 25% US Large Value, 25% US Small Value, 10% Intl Large Value, 10% Intl Small Value, 5% ex-US REIT, 15% US REIT, 10% Long-term treasuries; Stay the course!

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