BlackRock’s Tony DeSpirito is now shooting for dividends that are smaller but more reliable in his fund. This is only one small step toward the miles these funds are behind.
It’s no secret that those who call themselves equity income investors are obsessed with dividends, in a way that is very unhealthy. This comes up fairly often in the financial media, and we do a story on this topic every once in a while ourselves, to at least provide some contrast with common sense. It is an uphill battle.
It is even hard to get our heads around how investors manage to rationalize taking a fairly minor component of return and viewing it so out of proportion, to the extent that this either is their primary motive or even their singular one. This obsession does not even seem to know any bounds, where even in the midst of a bear market, all they seemed to be worrying about is their dividends being cut, while their profit and loss statements bled profusely from a much bigger wound.
When people look for a job, and are considering what one particular job pays over another, we would assume that they would want to be asking what the pay levels are, instead of focusing on a particular aspect of their compensation such as the level of a bonus and not add things up to see what the total compensation of competing opportunities are.
The first thing we need to establish to set up our analogy is to assume that the goal of investing is to make money. This should never be controversial, as while there may be non-financial reasons to prefer one job over another, for instance the fact that you like doing one job more, investing is purely measured in monetary terms, where the goal always is to make money.
The two jobs that we are choosing between both provide a similar level of satisfaction and are identical in every way other than paying us different amounts. We’re out to be compensated in this case, and prefer more money to less money, just like we are at least supposed to be doing with our investments.
The first job pays us $95,000 in salary plus $5,000 in bonuses, for a total compensation of $100,000. The second job pays us $40,000 in salary plus $10,000 in bonuses, where we get $50,000 in total, half what the first job pays.
If someone told us that they prefer the second job because it’s bonus is twice as high, that would be incredibly stupid, beyond belief actually, and it’s even hard to imagine how handicapped someone would have to be to choose the second option. Anyone found choosing this would be assumed to be suffering from some sort of significant brain damage, as even a minimally working brain would be enough to perceive the delusion involved, rather than being swept up in it.
Assuming that someone would need to have brain damage to want to happily accept half the pay when they also tell you that they want to get paid more might seem like an exaggeration, but if anything, this understates things, because we see people that have had massive strokes and can barely speak, and have great difficulty putting together thoughts, but still have retained enough brain function to know that $100,000 is more than $50,000. Even babies know that two toys are better than one, and at no point in human development do we lack the ability to make these fundamental distinctions.
On the other hand, it would be difficult indeed to go out there and find someone who would choose and defend the choice of the lower paying job. This is the same job exactly other than choosing the means of compensation, and the absurdity involved is completely isolated and transparent.
It’s easy to find people who are happy to make this unspeakable mistake with their investments though, and aren’t even trying to compare. Prioritizing dividends commits the exact same mistake as the person who chooses the $50,000 does, looking at how much bonus they will earn but not caring about how much money they will earn.
It turns out that the minds of many are easily deceived, in a manner that we should find just as disturbing as those who choose the higher bonus but much lower pay overall, where they completely seem to miss the fact that the value of investments and how much we make from them are decided by things other than dividends.
Whenever we see someone in the business promote this deception, we want to at least put up our hands and ask them what should be an important question, which is how their ideas stack up in what really matters, how much money that we may expect to make, what this job pays when we look at not only the bonus payouts but the entire sum that is made.
The cries of pain that we heard recently from the dividend promoters and those under their wing were very real, where there was a mad scramble to avoid dividend cuts, to mourn over a couple of percent of bonuses when your overall pay was slashed by 10 times this amount or more.
In the aftermath of this, people like portfolio manager Tony DeSpirito, who both manages BlackRock’s mid cap dividend fund and also serves as their Chief Investment Officer of U.S. Fundamental Active Equity. We’re not exactly sure what that title means, but we assume he is in charge of people who use fundamental analysis to actively manage U.S. stock positions.
Using fundamental analysis to decide between stocks in itself scares us, even though this is so prevalent, but the mistakes this strategy makes, looking so much at things not correlated with performance very much, and not even having the wherewithal to notice, are nothing compared to mistakes dividend investors make.
Changing Dividend Payouts Matter, Changing Values of Shares Really Matter
Advice on dividend investing is very commonplace, but what makes DeSpirito stand out right now is his idea of looking to not seek the highest dividend stocks any more, but to instead take a more middling approach, where dividend risk is more accounted for.
DeSpirito is afraid not of these higher dividend stocks being weak, he’s actually concerned that they will cut their dividends, which as bizarre as this should seem, is totally consistent with the approach of blinding ourselves to anything but dividends in the manner that our brain-damaged friend choose an extra $5,000 in bonus over an additional $50,000 in compensation.
Such an approach happens to be not only unwise but reckless, like enjoying a cat sitting on your lap so much that you will drive your car with your cat purring on your lap and content enough to close your eyes and drive down the road without any attempt to avoid getting into an accident. You even realize that you may crash your car, but are only worried about the cat being thrown from your lap when you get into an accident, not your going through the windshield, where the fact that you are placing your financial life in danger is somehow ignored.
Fund managers need to take responsibility for their actual results, which include more than just what dividend payments they are collecting, They pretend that the changing value of a fund doesn’t matter, even though this is the only thing that matters and the only way to measure and compare funds.
As interesting as we find DeSpirito’s approach to look to cull the highest dividend paying stocks from the fold now since he is concerned about these dividends being cut, the idea behind this and any other decision about a fund you manage is to drive results, and ultimately how a fund does compared to other funds is the only sensible way to decide these things.
To compare with his dividend fund, we’ve selected another of BlackRock’s funds, a pretty standard one actually, the iShares S&P 500 Growth ETF. This is actually a great comparison, as the BlackRock Equity Dividend Fund hitches its cart to dividends, while the growth fund shoots for capital gains through price growth.
We’ll start by looking at how these two funds have compared this year. We’ll compare both dividends and price growth, and then add them up to see how they stack up. The dividend fund has earned a return though dividends this year of 2.56%, where the growth fund has added 0.5%. The dividend fund therefore has pulled ahead by 2.06%. We’re not done calculating though, and far from it.
Dividend investors just look at this and think that this dividend fund is the better of the two, and dislike the low dividends of a growth fund like this. This extra 2% does contribute to their return, but let’s now look at how these two funds have moved in price.
The iShares S&P 500 Growth ETF is up a fairly modest 27.36% so far this year, and when we add in the little in dividends that they have earned, we get a total return for 2020 of 27.86%. This is better than the S&P 500, and since it’s a growth fund, they at least have managed to focus on stronger stocks more, otherwise known as growth stocks, than the big index does, which does not select based upon performance. There are plenty of better funds out there that are even more focused on performance, including indexes like the Nasdaq 100.
If you are a growth fund, you may beat the undifferentiated S&P 500, but unless you beat the Nasdaq 100, you don’t have a real claim on the money of investors since you have failed to beat the market basically. We didn’t want to make this test for our dividend fund too challenging, and just comparing between two fund managers down the hall, one looking to pick stocks based upon dividends and the other is at least trying to select by way of price growth, makes sense.
Dividend Funds Simply Flunk Out of School
It’s time for the overall report card on the dividend fund, and we see that it has fallen behind by 12.11% so far this year. We do get to add in their positive dividends, and end up with an overall return of -9.55%. The growth fund has therefore outperformed the dividend fund by 37.41%.
This is the decision that dividend investors face, whether the extra 2% in dividends is worth giving up more than 34% overall, or even better, whether they find themselves happy to get this couple of extra percent when they end up losing almost 10% overall.
We could try to convince these investors to pay us $100 a month for the privilege of earning a payout of $20. All they have to do is keep their minds on the $20 a month that they are getting and completely ignore that this is costing them $100 to earn this $20 and perhaps they will be happy about this deal.
When they us that we must think that they are out of their minds to agree to such a bonehead deal, we can tell them that we do indeed think that they have lost their minds when they do the exact same thing with their stocks. If they gain 2.5% but it costs them 11%, and actually costs them a total of 37% when we factor in opportunity costs, the cost of being in this dividend fund versus this other fund this company offers needs to be accounted for.
We’ll look at how these two funds stack up a little further out, over the last 2 years instead of just the last 8 months. Maybe people are thinking that the problem is that dividends were cut this year, or this was some sort of anomaly caused by COVID, where this otherwise fine dividend strategy has been infected this year but are otherwise healthy.
We’ll start with the growth fund this time, which ran up by 44.35% over the last 2 years running. For comparison, the Nasdaq 100 is up 67.16% over this time, and therefore this stock falls well short of competing with the market or coming close, as giving up over 12% a year is a big enough slap in itself.
The dividend fund doesn’t just get slapped by the Nasdaq, it gets pounded, and the pounding that the growth fund lays on them is plenty big enough. Our dividend fund has had their shares drop by 21.81%. This works out to over 10% per year, and even if you get 4% a year on dividends, this still leaves you with a hefty loss. Ignoring hefty losses is not the way to build up your portfolio.
When you consider how much the stock market has moved up over the last 2 years, and get left with an embarrassing loss rather than a big gain, this should at least nudge you awake a little. It should actually shock you right out of bed, but only if you are actually pay attention, and the dividend investors that do get up from the floor and start running.
Let’s look further out, over the last 10 years, and then work out the average return per year. We’ll give the dividend fund this 2% per year that they earn in extra dividends and then see how far that goes.
The growth fund is up an average of 33.10% over the last 10 years, while the dividend fund has gained an average of 1.52% over this time. There’s a much bigger difference between 33.10 and 1.52, and once this 2% is thrown in as well, we can see that the dividend strategy has underperformed by an average of 29.58%.
We might think that giving up this much per year could somehow be worth it if dividend funds managed risk that much better, as ridiculous as this should seem to us giving the huge gap in return. The dividend fund has a beta of 0.96 over the last 3 years, where the S&P 500 is a beta of 1. Our growth fund has a beta of 0.97 though over this time, meaning that it only goes down a hair more during pullbacks. Growth funds come back from these things faster, moving down a hair more but moving up a handful of hair more.
Whether DeSpirito manages to avoid dividend cuts or not, this fund is a sick puppy and it’s going to take a lot more to fix what is wrong with this kind of fund. We certainly think that it is a fine idea to look to maximize dividends by avoiding stocks that have bigger dividends but at more risk, and this is a calculation that makes sense if that is your thing. Unfortunately, this is like putting a band-aid on a small cut on the face of a person that got hit by a car and thrown into the ditch, as this pales in comparison to the real injuries and is still going to have us pretty hurt.
Investing for dividends not only does horribly, it does not even make any sense, if we think about this a little. If we are paid in both bills and change, just counting the change and not even considering counting the bills is completely foolish, enough so that no one should find themselves getting caught in this trap.
We play this game for money and we would think that how much money we make would matter more than this. It’s not even that people look at funds of any sort independent of rates of return, but people have been conditioned to only look at these things within categories, like how DeSpirito’s fund may stack up against other similarly wayward funds.
These funds have also served to mesmerize investors to not look at their results, and this is required for anyone to want to get in or stay in these funds. However, this is because the people who run these funds are similarly mesmerized, with everyone involved living underground, including the advisors who sell these things, all unable to contemplate what may be happening up on the surface.
It really is as simple as just thinking how your dividend fund may compare to other types of investments such as a growth fund, and all you need to know is that a lot more money is just better to have the truth set you free.