In the competitive landscape of investment advising, exchange-traded funds (ETFs) have gained traction among many financial advisors. However, a concern persists regarding the quality of ETFs recommended to retail clients. Often, these recommendations arise from a complex network of ETF wholesalers who market their products directly to advisors through various persuasive tactics, such as luncheons, conferences, golf outings, and visually appealing pitch decks.
This dynamic can lead to scenarios where an advisor, after an enticing dinner meeting with representatives from a prominent asset management firm, suggests an ETF that the client has never encountered before. This practice raises questions about the transparency and quality of the financial advice being provided. Unfortunately, many worthwhile funds that are popular among do-it-yourself (DIY) retail investors, such as the Schwab U.S. Dividend Equity ETF (SCHD), seldom receive attention in advisory practices.
Schwab’s SCHD has captured the interest of investors, particularly among those focused on total returns, thanks to several appealing attributes. Its low expense ratio of just 0.06% stands out; with a $10,000 investment, this translates to an annual fee of merely $6. The ETF’s current yield of 3.31% has also made it an attractive choice, yet its appeal lies beyond just income. The underlying quality and value factor exposure make SCHD particularly noteworthy.
To better understand SCHD, it is essential to delve into its operational mechanics. The fund passively tracks the Dow Jones U.S. Dividend 100 Index, employing a fundamentally weighted approach rather than a traditional market-cap weighting. The ETF requires companies to have a solid track record of paying dividends for at least ten consecutive years, followed by a rigorous evaluation based on free cash flow relative to total debt, return on equity, dividend yield, and five-year dividend growth rate. Only the top 100 companies that meet these criteria are included, with the portfolio being rebalanced quarterly and the index reconstituted annually.
Despite a relatively high turnover ratio of 43.17%, SCHD benefits from the structural advantages of being an ETF. Shares are created and redeemed through authorized participants, enabling the fund to avoid many of the capital gains distributions that mutual funds typically pass onto investors.
The real allure of SCHD lies in the quality and value exposure it offers. As of late April, the ETF was trading at just 18.98 times earnings and 10.83 times cash flow—significantly lower than the wider S&P 500 index. Moreover, it reports robust quality metrics, with an average return on equity of 26.64%. Such qualities have been particularly advantageous, as evidenced by a year-to-date total return of 17.9% by the end of April.
Tax efficiency is another benefit, with most distributions from SCHD qualifying as qualified dividends. The ETF’s strategy of excluding real estate investment trusts (REITs), which often produce less tax-efficient income, enhances this advantage.
As retail investors navigate the complexities of ETF offerings, they may want to challenge their advisors to explore SCHD more thoroughly, especially before committing to pricier dividend strategies that may emerge through wholesaler recommendations. Given its impressive blend of low costs, quality holdings, and tax efficiency, SCHD may offer a more enticing option than many advisors are inclined to suggest.
