Taking the Best of Low-Volatility and High Dividends with Franklin Templeton

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Avoiding losses is such a powerful motivator in investing that behavioral economists have studied the phenomenon and found that individuals perceive actual or potential loss as psychologically or emotionally more severe than an equivalent gain.

Given that incurring a loss throughout one’s investment journey is inevitable, a more practical approach risk-conscious investors should consider is low-volatility investing.  Recently, Franklin Templeton launched a new suite of low-volatility solutions with a high dividend factor focus, offering investors lower equity risk exposure within a universe of attractive income-yielding dividend stocks.

This article will highlight the investment strategy underlying these new solutions and detail how they can benefit investors.

Franklin Templeton’s Low Volatility Suite

Franklin Templeton Canada’s low-volatility strategies allow investors to benefit from a proven investment strategy that provides them with innate risk mitigation and a selection of high-dividend equities best suited to thrive during economic cycles’ ups and downs. Presently, the suite has three ETF solutions that provide exposure to Canada, the United States, and International Equity markets. The Franklin Templeton low volatility ETFs are, Franklin Canadian Low Volatility High Dividend Index ETF (Ticker: FLVC), Franklin U.S. Low Volatility High Dividend Index ETF (Ticker: FLVU), and Franklin International Low Volatility High Dividend Index ETF (Ticker: FLVI).

Looking at the dividend income aspect

The importance of dividends in total equity return performance has been documented across various investment research and is observable in equity market performance. By examining the performance of the S&P 500 Price Return Index and S&P 500 Total Return Index over the past two decades, we can demonstrate the seminal importance of dividends across differing periods. As observed in the following chart, while the contributing impact of dividends varies over each 5-year window, its additive component is irrefutable.

Though a company’s ability to issue dividends consistently is noteworthy, firms capable of growing their dividend or those able to issue a high dividend tend to outperform their peers. For example, for companies classified as ‘Dividend Growers & Initiators, the S&P 500 Dividend Aristocrats Index is a good barometer for assessing overall performance. A Dividend Aristocrat is a company in the S&P 500 Index that has paid – and increased – its base dividend every year for at least 25 consecutive years.

In looking at the long-run performance relative to the S&P 500 Index, the S&P 500 Dividend Aristocrats Index has clearly outperformed over the long term. Additionally, companies offering the highest dividend payout level exhibit compelling performance, and the S&P 500 High Dividend Index reflects this ideology, providing exposure to the highest quintile of dividend-paying stocks in the S&P 500 Index.

Looking at the low volatility aspect

Low-volatility portfolios are comprised of less volatile stocks than their peers, which means that on a risk-adjusted basis, they may exhibit superior performance and provide exceptional returns relative to other portfolios. Low volatility can be measured in two ways.

The first is standard deviation, which measures the volatility of each stock on a standalone basis, and the second is beta, which measures stock volatility and correlation relative to the overall market. The market has a beta of 1.0, so a stock with a beta below one is considered less volatile than the market, and vice versa for a stock with a beta above 1.0.  

Low-volatility portfolios are not impervious to market drawdowns. Over the last two decades, equity markets have faced numerous shocks to the system. When those situations occurred, low-volatility portfolios generally outperformed (i.e., lost less) the broader market. The following table shows that recent equity market drawdown periods demonstrate the efficacy of low-volatility strategies.

Please Note: Minimum Volatility portfolios have investment objectives similar to those of Low Volatility portfolios, but the approach taken differs. Minimum volatility portfolios determine the historical return volatility and correlations of all the individual stocks in the benchmark, then utilize an optimization approach to construct the least volatile portfolio based on their weightings and observed relationships over time. The MSCI EAFE Minimum Volatility NR USD Index is used as a proxy for a Low Volatility portfolio to demonstrate the strategy’s effectiveness, as results would be fairly similar.

Considering the market events that have adversely impacted the equity markets and the global economy in recent years — COVID, supply chain disruptions, the Russia-Ukraine War, and rising inflation—low-volatility portfolios have effectively mitigated losses relative to their parent indices. Though the degree of loss mitigation may vary across each event, the underlying investment strategy has demonstrated the ability to fulfill its intended objective.

Taking the best of low volatility and high dividend

Franklin Templeton’s low-volatility ETFs follow a rules-based approach, beginning with the respective investment universe of each fund and then screening for stocks with sustainable high dividends and strong company fundamentals. The dividend screen filters for stocks that have paid and are projected to continue paying relatively high dividend yields. Regarding strong company fundamentals, preference is given to stocks that have demonstrated profitability over the past four quarters and are projected to remain profitable over the next four quarters; ensuring that selected companies have the earnings power to support their dividend payment.

After the sustainable high dividend screen is applied, selected companies are evaluated using a low-volatility measure of historical price volatility and both historical and forecasted earnings volatility.

The final evaluation stage assigns a stable yield score, which combines the sustainability of the dividend yield with volatility measures. This results in a score of sustainability dividends and low volatility; in turn, the portfolios are constructed with stocks with the highest score.

Understanding why this approach is impactful

Franklin Templeton’s low-volatility solutions cater to two key investor needs: generating income and minimizing losses. By blending high dividends with low volatility, investors may achieve a more stable and dependable investment approach. Analyzing the historical strategies of each approach helps us grasp the advantages investors can gain.

Conclusion

For Canadian investors seeking intuitively low volatility and income-oriented solutions, Franklin Templeton’s suite of low-volatility ETFs provides dual exposure to these attributes in a turnkey manner. Given the geographic focus of each solution, they can be utilized as core holdings within a portfolio or in a complementary manner with existing solutions in a balanced portfolio.

This article is content sponsored by Franklin Templeton. 

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.

Commissions, trailing commissions, management fees, brokerage fees and expenses may be associated with investments in mutual funds and ETFs. Please read the prospectus and fund fact/ETF facts document before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses, and other factors. Indicated rates of return are historical annual compounded total returns for the period indicated, including changes in unit value and reinvestment distributions, and do not take into account any charges or income taxes payable by any security holder that would have reduced returns. Mutual funds and ETFs are not guaranteed. Their values change frequently. Past performance may not be repeated.

ETF units may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF units will develop or be maintained, or that their listing will continue or remain unchanged. While the units of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.

Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp.