SCHD: Overrated Dividend ETF, Lots Of Downside Risk (NYSEARCA:SCHD)

The Schwab US Dividend Equity ETF (NYSEARCA:SCHD) is living off of the reputation it gained as a “best in class” dividend ETF during a limited period of time. That doesn’t make it a bad fund to own. I’d place it solidly in a group of ETFs that I have alluded to briefly in this article, since the focus here is on the pros, cons and specifically the dangers I see from the gushing compliments SCHD receives from Seeking Alpha readers and elsewhere.

Is it a solid dividend ETF choice? Yes, it is OK. Does it have some risks based on assumptions that many investors are making about what it is and isn’t, and some realities about its past performance? I think that is also true.

And so my thesis here is not to buy or sell SCHD, but to recognize it for what it is: an ETF that is a decent plug in for a combination of yield, valuation and total return growth potential. But is it night and day ahead of its peers on a forward-looking basis? No way, I say. I rate it a Hold since applying a rating is part of the deal here, but my main conclusion is that it is over-rated based on the amount of assets that have flooded into it, which I believe is based on a heavy dose of past-performance-driven buying by investors. This happens in every market cycle, to many asset classes. You might say that SCHD, JEPI and ARKK all have this in common:

1. A short period of remarkable outperformance of peers

2. A surge in AUM that looks like a combination of good marketing by the ETF company, but just as much the classic recency bias we see so often in modern markets.

SCHD is not a “bored ape”…but I’m bored from hearing about it

I can’t control how anyone else positions it in their own portfolio, and I don’t and won’t own it in my own for reasons explained below. However, if I were forced to own it, I’d give it some company in the form of disaster protection, as I do in the portfolio of 40 stocks I am nearly finished building out via my “Yield At a Reasonable Price (YARP)” dividend stock methodology. So I am knee-deep in dividend stock research these days. And I will say that the holdings of SCHD have a decent amount of overlap with my own. However, that doesn’t mean much, since my approach is far more tactical, in that my stock basket does not turn over much, as with many index ETFs. But the weightings of the stocks do fluctuate much more often.

With any dividend ETF (and I have owned plenty of them over the years), I think it is vital to have some form of downside protection. That’s because there’s a litany of historical examples to show us that SCHD is as prone to stock market disaster as any other dividend ETF. Yet the sentiment toward it implies it is Superman.

Portfolios are not destroyed by down markets, but people destroy their wealth if they don’t understand what they own and why. Because the time to figure out the risks in any investment is definitely not when it just removed a big chunk of liquid net worth.

The best sales pitch SCHD has ever had

I think this is where the Superman complex developed around SCHD. From the day the pandemic crash ended (March 23, 2020) through mid-April of the following year, 2021, SCHD did what is rare for a “dividend” ETF to do, although it was not the only one to do it. Specifically, it doubled in price including dividends over just more than a year.

Starting about six months after the beginning of that sharp runup in the SCHD, in which it kept pace with the SPDR S&P 500 Trust ETF (SPY), SCHD continued up, along with many other dividend ETFs. But while the ETF rose by about 60% from late 2020 through last week, the assets in SCHD rose more than 330%, 5.5 times the growth of the fund’s price!

SCHD now manages over $55 billion in assets. Outstanding for them, outrageous in some ways, given that I truly believe this is one of the biggest performance chases in modern US stock market history. Again, not a bad dividend ETF. But it shouldn’t be this big, and it remains to be seen how that impacts SCHD and its biggest stock holdings in the months and years ahead.

The tail can wag the dog in ETF investing, such that a rough patch for some of those stocks might lead investors to sell the ETF. And when that happens with an ETF this big, that can create an uncomfortable “catch-22” situation. This has occurred in every market cycle, and while SCHD is a big ETF for its peer group, SPY and QQQ are the ones most vulnerable to a situation where a market selloff begets panic selling in the stocks, and it feeds on itself. Look back no further to the start of that period I mentioned earlier, the 5-week mad scramble in early 2020. Five weeks, 33% down for SPY.

How my take on SCHD and dividend investing is different from most

This is not a prediction, but all I can do is size up the odds of different scenarios, manage “tail risk” that is market meltdowns, and use as little capital to do it. Oh, and explain to investors that simply relying on “long-term investing in dividend stocks” only works when that inanimate object, the stock market, helps out. Many investors rely on “the market” to help them. I prefer to use the market as a tool to get what I want: as smooth a ride as possible, as much dividend income as I can obtain responsibly, and avoiding common traps like thinking SCHD is more than it is.

Now, here are a few pictures and data tables to drive home my thesis. This one shows that SCHD, despite that huge advance described above, was a pedestrian, average performer among its peers during 2021-2023. Not bad, but also not one of a kind, as that assets under management spike would imply.

SCHD has not guarded against major declines in the US stock market, except during the first half of 2022. This is likely the other reason for the surge in assets into the fund in recent years. It lost much less... once. Because as shown below, it did not protect significantly in 2020, 2018 or 2016.

SCHD fell every bit as much as SPY in 2020 (33%), fell “only” 17% in 2022 vs. 24% drop for SPY and 17% in 2018 when SPY dropped 19%. So in my view, SCHD is only as good as a bull market in stocks.

This is why I truly believe investors need to remember that dividend stocks are just stocks with a higher payout from the stock price each quarter than other stocks. There is no stock market segment that consistently plays great “defense,” which is why I use other methods to protect my YARP dividend stock portfolio. For instance, inverse ETFs, put options, and the aforementioned position weighting changes in the stocks themselves, which often results in raising some cash. And with cash yielding 5% these days, that “defensive weapon” is as fine as it has been over the past few decades.

Before the pandemic, the style SCHD runs was actually highly correlated to a dividend ETF that only buys tech stocks in the NASDAQ that pay dividends. That indicates that there was some tech exposure that helped SCHD for a while, and in a way that jacked up its performance and likely was not fully understood by people buying the stock. Flying tech stocks are not what drives dividend ETFs over the long-term. Apple (AAPL) was likely part of this several years ago, as it yielded 3% for a short time, and qualified for this ETF’s portfolio.

A look at holdings from two months ago versus the end of last month is telling. Broadcom (AVGO) was the biggest holding in SCHD, despite its yield dropping toward 1.5%. But it briefly yielded more than 6% in early 2020, and so as with AAPL before it, one or two stocks can be responsible for that temporary return boost. That’s great, as long as that type of thing keeps happening. I’m not so sure it will continue to occur. That will not make SCHD a bad ETF, just one that has lost its “fastball” unless another AAPL or AVGO situation comes along. As shown below, AVGO is not in the top 10 anymore, and in fact has exited SCHD.

But it was great while it lasted. When one holding produces 15x the return of the ETF in total, that is a lopsided way for a “dividend” ETF to roll, but I’m certainly not arguing with the success it brought. I am just using my analytical approach to try to dissect what caused SCHD to get so popular, in hopes that investors will have their eyes wide open going forward.

I like most of the current portfolio, and will probably even compare it to my own 40-stock YARP-driven mix soon.

That said, here’s why I prefer rotating position sizes frequently, even while owning the same stocks. Typically, 1% to 5% is my holding range (at cost). As noted here, 3.37% yield is OK, but I aim to double that or more via position rotation. 100 stocks is a bit too many for me, and a 16 trailing P/E is not cheap, especially for that expected growth rate.

SCHD: Just one of the crew

SCHD is not a dividend ETF for the ages, so to speak. It is a dividend ETF that usually does about what its peers do, but had a couple of momentary jumps in price in its history that, for reasons I can’t quite totally explain, made it a $55 billion ETF. I’ve been a Schwab client for decades, but this Schwab ETF is not special to me. I tend to gravitate toward SPHD, SDOG and SPYD when I do use dividend ETFs, and own SPHD now.

However, most of my dividend stock exposure is my own portfolio selection, stock by stock, as I will focus on in an upcoming article. I decided it was best to express my views on the uber-popular SCHD before going into detail about that.

So, SCHD is competitive in its peer group, but a Superman ETF it is not. It has some history that investors should know as well as the brief time periods in which it performed uniquely well. After all, investing is risk-management, and much more than “buy what just went up.”