ABOUT John Jacobs

I provide strategic insight and counsel to Global Information Services (GIS) and Nasdaq since my retirement as Executive Vice President in January of 2015. Prior to my retirement, I was responsible for all aspects of Nasdaq’s information product business development, including the creation and licensing of strategy indexes in the U.S. and abroad. I am known widely as a pioneer of indexing and ETFs, and under my leadership, Nasdaq launched the Nasdaq-100 Index Tracking Stock® (QQQQ), one of the most successful financial products in stock market history. To date, Nasdaq Global Indexes has launched over 2,900 products based on Nasdaq indexes in more than 27 countries around the world. Among my former responsibilities at Nasdaq, I served as Chief Marketing Officer, launched and led Nasdaq's first listed-company sales force, and managed the company's customer service teams. Also included in my broad range of experience is management of Nasdaq's listings and compliance group, which reviews and processes all SEC documents and financial filings. Additionally, I was part of the team that garnered a "yes" vote from more than 5,000 NASD member firms to spin off Nasdaq. Since then, he was part of the core group that successfully orchestrated the first two rounds of Nasdaq's private placements, paving the way for Nasdaq to become a publicly traded company. I earned my BS in accounting from the University of Maryland, and am a certified public accountant (CPA), and I hold an MBA from Loyola. I have taught Investment banking and other graduate courses in the MBA programs at both Johns Hopkins University and Georgetown University. For over 10 years, I served as a judge for both the Washington, D.C., and New York City Ernst & Young Entrepreneur of The Year Award Programs. I have also presided as a judge for the MBA competition at the University of Maryland. In addition, my past service includes Boards of Nasdaq Global Funds, Inc., Nasdaq Financial Products Services Ireland Limited, The Nasdaq Insurance Agency LLC, the Board of Advisors of CourtExpress, Inc., and the Editorial Board of the Journal of Indexes.

Posts by John Jacobs

Video: John Jacobs on The Future of Our Index Business By: John Jacobs
on 8/1/2014

John Jacobs, Executive Vice President, NASDAQ OMX Global Information Services, addresses the the future of our indexing business in the fifth installment of his video series.

Transcript: Let’s take a look at where we think NASDAQ OMX Global Indexes will be in a year or two down the road. As a global indexer with multi-asset classes, our near term strategy is to continue to roll out our superior technology on two fronts: The ability to calculate more indexes across more asset classes, so you’ll see us adding in more asset classes like fixed income and commodities. And the ability to have a superior data offering. We’re going to be able to offer data in a far more convenient fashion to the end user in a better way than it’s ever been offered before. So those are two near-term strategies. In addition, there’s been a tremendous movement and demand from the buy side and the sell side, those firms on the street, and those ultimate investors, for more custom capabilities and calculation, and we’re going to be offering a lot more custom indexes to partner with different firms, so they can find exactly what they want for their investment thesis. Whether they want geography or style or some other asset class, we’ll be able to provide that for them. So you’ll see a lot of growth in the custom [indexing]. You’ll continue to see us roll out more exchange traded products. You’ll see more structured products, and you’ll see a richer data set come out from us, both price data and weights and components. We also have recently announced that we’re acquiring eSpeed, which is a fixed income business, so you’ll be seeing a rich data set from fixed income, on-the-run treasuries, and an index family as well. So the next one to two years is going to be a very exciting time for NASDAQ OMX Global Indexes as we continue to fill out our mandate of multi-asset class, a scalable technology solution, create a better value proposition, and the richest, most robust data set in the index business.

Video: John Jacobs on the Advantages of Being Part of a Global Exchange Company By: John Jacobs
on 7/15/2014

John Jacobs, Executive Vice President, NASDAQ OMX Global Information Services, explains the advantages of being a part of a global exchange.

Transcript: The fact that NASDAQ Global Indexes is part of the NASDAQ OMX Exchange company gives us some great advantages. For example, since we power 75 markets around the planet, we have natural inroads and connections to those markets that allow us to reach those market participants and they, in turn, are the gateway to the investors. That’s why you’ve seen NASDAQ OMX Indexes, like the NASDAQ-100, for example, start being launched in ETFs and other kinds of products around the planet. We’ve got access to the local marketplace through those connections. In addition, those markets are operating on our trading technology, which is the basis for our index technology. So, again, we have a natural conduit to be able to partner in local markets. The other advantage of being a part of this exchange company is that NASDAQ OMX owns a variety of derivative exchanges, those in Europe and in the US, where we are the number one options market, for example. And when we go to ETF sponsors and other product sponsors, and we can say, “look, if you pick our index, versus another indexers benchmark, we can guarantee you that, if it’s options eligible, we will get an index option launched on your product.” And we’ve all seen that the most successful products out there are the ones that have a variety of different products on them. So you take an index, you launch an ETF and an option, and a future, and structured products, and it appeals to a wide variety of investors and traders. That ensures the most success for all the products. They don’t really compete, they are complementary. So, again, being part of this larger family, gives us great opportunities to leverage the assets of this overall company.

Video: John Jacobs on How Index Providers Compete on Price & Value By: John Jacobs
on 7/8/2014

John Jacobs, Executive Vice President, NASDAQ OMX Global Information Services, addresses the Importance of Value and Price in the Index Data Business in the third installment of his video series.

Transcript: I absolutely think indexers will compete more on price in the future. I think the bigger question is less about price and more on value. So as we’ve mentioned before, indexers, modern indexers are moving toward; full-service ones have to be multi-asset class and it has to be a scalable model, not just a technology scalable model, but a scalable model across every facet of what they do. You have to be nimble and lean when it comes to index administration, and operations and when it comes to rolling out your data in a variety of different formats. NASDAQ OMX, as part of the NASDAQ OMX Group, NASDAQ Indexes has always been a very efficiently built organization. Our goal is that the next 10,000 indexes, shouldn’t cost the same as the first 10,000 indexes. So we are continuing to roll out a superior set of indexes with an additional value proposition at the lowest possible cost. And cost matters to all the downstream users of indexes, so we are absolutely committed to being the low cost provider of indexes, data, components and performance to all the users of indexes downstream. So, I think, you’re going to see more and more, as you see in the environment with some of the ETF providers today, looking and switching benchmarks out to find ones that can give them, probably, better cost structures and certainty of the pricing of their products. We are absolutely going to continue to drive to be the low-cost index provider.

Video: John Jacobs on The Importance of Scalable Technology By: John Jacobs
on 6/24/2014

John Jacobs, Executive Vice President, NASDAQ OMX Global Information Services, addresses the Importance of Scalable Technology in the second installment of his video series.

Transcript: To be a full service index calculator, and the world is moving to a smaller number of much larger full-service index calculators or indexers, you need a robust calculator. This business is moving to a model that’s built on scale, a technology scale. That is a strong spot of the NASDAQ OMX Group and we built the most scalable technology to trade securities around the planet. Now I say securities specifically, not just stocks, because we power a variety of different kinds of markets. So when it comes to an index calculation, you need to be able to calculate a variety of indexes across multiple asset classes; Not just equities, but commodities, you need to be able to do currencies, you need to be able to do fixed income and a variety of other things. It needs to be fast, it needs to be able to take in multiple data inputs, and it needs to be able to deliver that in a very robust data center that can be consumed by investors a lot of different ways. You can’t build that with a very expensive cost structure, it won’t be competitive. So that is the importance of having a technologically scalable index calculator at the core of your index business and we are very excited that we have built what we consider the absolute state-of-the-art best one on the planet.

Video: John Jacobs on Growth in the Dividend & Income Index Business By: John Jacobs
on 6/18/2014

John Jacobs, Executive Vice President, NASDAQ OMX Global Information Services, addresses the growth of Dividend & Income Index Strategies in the first installment of his video series.

Transcript: Since 2007, 2008, since the financial crisis, it’s been very difficult for institutional and individual investors to find yield. So dividend investing has a lot of advantages because it guarantees investors a yield on their portfolio instead of just relying on the performance of the stock, or the underlying stocks in the ETF. So with the acquisition of the Dividend Achievers suite of products, we can marry that with our income family of products and offer investors a suite of different indexes to use. The indexes are a basis for a variety of ETFs and other types of products and it’s another stepping stone for NASDAQ as we continue to build out our Global Index business, which has become multi-asset class and, as well, multi-different investment style.

NASDAQ OMX Global Indexes is named the Most Innovative Index Provider of the Year by ETFExpress By: John Jacobs
on 2/27/2014

NASDAQ OMX Global Indexes has been named the Most Innovative Index Provider of the Year by the 2014 ETFExpress Global Awards. The award was presented in late February at the ETFExpress Global Awards gala in London. NASDAQ OMX Global Indexes gained the largest amount of votes in an online poll to win the title. Among the reasons for their win:

NASDAQ OMX is one of the only index providers to have products listed globally covering equities, commodities, and fixed income.

As of 2013 year-end, NASDAQ had 148 licensed ETPs globally with approximately $92.3 billion in assets under management. The ETPs based on NASDAQ indexes are listed in 16 countries, and NASDAQ OMX is the first index provider to have its indexes linked to ETPs in China, India, and Iceland.

In October 2013, NASDAQ OMX launched the NASDAQ US Rising Dividend Achievers Index, a continuation of the Dividend Achievers brand. The index was designed to include stocks that are best positioned to continue dividend increases, and the methodology includes both several dividend criteria and balance sheet criteria. The largest dividend ETF with just under $20B in assets under management tracks the NASDAQ US Dividend Achievers Select Index.

Another innovative move took place in 2013, when NASDAQ OMX partnered with Accretive Asset Management to co-brand and grow BulletShares, the first fixed-maturity corporate bond indexes; since then, assets have grown in BulletShares ETFs substantially and the NASDAQ BulletShares Ladder indexes were launched.


Interested In Investing In Technology Stocks? By: John Jacobs
on 2/24/2014


Technology companies have always been classified as growth machines, aggressively reinvesting profits and thereby sowing the seeds of innovation and future profit growth. However, individual investments in tech stocks can be a polarizing subject amongst individual investors. This is primarily due to factors surrounding the competitive nature of management, culture and corporate governance. For these reasons, owning a basket of tech stocks in the form of an Exchange-Traded Fund (ETF) may be a better strategy for some people than individual stock selection. ETFs take nearly all of the individual fundamental attributes of stocks out of the equation, allowing investors to focus on select areas of the technology ecosystem.

The opportunities in technology and the sheer number of options available for ETF investors have never been more abundant. When allocating to a technology-focused ETF, key considerations should include (1) index selection (2) fund size and (3) strategy. Striking together an intuitive balance of funds with growth or income potential could add a supplementary facet to an otherwise traditional portfolio management approach.

Shopping for an ETF by trying to compare and contrast performance and individual fund characteristics is often times an arduous task. However, it doesn’t need to be when you consider that nearly all of the details on security selection are spelled out in plain black and white. You simply need to formulate what your portfolio goals are and how you can integrate an appropriate technology ETF into your portfolio to align with those goals.

Now that ETFs are considered a mainstay investment option for short and long term investors alike, sector ETFs encompassing every form of broad-based and industry-group specific strategies have amassed a bountiful landscape of imaginative and useful products.

One of the oldest solid-state products in existence that still contends popularity is the Technology Select Sector SPDR ETF (XLK). As the second largest technology ETF by assets under management, it was originally designed alongside it peers, the Select Sector SPDRS, to be part of the 10 individual sectors of the S&P 500 Index. XLK is market cap weighted, and envelopes the cross section of technology stocks strictly within the S&P 500. For this very reason, it carries a large concentration of large-cap stalwart tech names such as Apple AAPL +0.26% Inc. (AAPL), Google GOOG +1.15% Inc. (GOOG) and Microsoft MSFT -0.29%, Inc. (MSFT).

XLK offers investors an easy avenue of overweighting technology within a diversified portfolio of broad-based market indexes. However, it’s important to consider XLK’s lack of diversification outside tech names not admitted to the S&P 500. Which in turn leaves aside small- and mid-cap names in favor of large, well established companies with long operating histories.

Created through a collaboration of traditional index formulation and fundamental characteristic research, the First Trust Technology Alphadex Fund (FXL) is an ETF which ranks and then overweights companies with strong fundamental attributes. These traits include six and 12 month price appreciation, return on assets, book value to price and cash flow to price ratios. In the end, the top 75% of the screen marks 90 stocks for inclusion to the index ranging from small to large capitalization companies.

Investors seeking niche exposure in the world of technology stocks now have the option of investing in ETFs that target specific sub-sectors of technology. These products were created specifically for tactical investors that prefer a layer of diversification, but not at the expense of including an underperforming industry group within a specific sector.

Two examples of these ETFs are the First Trust Dow Jones Internet Index (FDN) and the PowerShares NASDAQ Internet Portfolio (PNQI). These ETFs are designed to track the largest, most liquid companies that generate at least half of their revenue from an internet related business. FDN’s top holdings include Facebook Inc. (FB), Amazon Inc. (AMZN) and eBay, Inc. (EBAY), while PQNI’s top holdings are also Facebook (FB) and eBay, Inc. (EBAY), as well as Google Inc. (GOOG). An aggressive investor might favor a position in FDN to hone in on the rapidly expanding growth of internet stocks engaged in content distribution or social networking versus companies engaged in the manufacturing and sales of technology hardware or software. Since FDN and PQNI are specialized strategies, it’s no surprise that their expense ratios are 0.60%, which is significantly higher than most broad-based ETFs.

Lastly, for investors seeking income from their invested capital, there is an index strategy that can leverage the strong free cash flow and healthy balance sheet attributes of mature technology and telecommunications companies. The First Trust NASDAQ Technology Dividend ETF (TDIV) tracks a specialized index that is comprised of companies across the capitalization structure that have a consistent history of paying dividends to shareholders. TDIV carries a current SEC Yield of 2.53%, and has an expense ratio of 0.50%. An investor looking to diversify a traditional equity income portfolio outside interest rate sensitive areas such as utilities or consumer staples stocks could utilize a fund like TDIV.

As the technology landscape has evolved over time, so have the need for products targeting multiple areas of the marketplace. ETFs have proven themselves to be one of the easiest and most efficient vehicles for exposure to individual sectors and industry groups. Evaluating and selecting the appropriate ETF for your underlying goals could ultimately yield the most favorable outcome, rather than investing in individual stocks.

*All performance statistics as of 2/3/14, data provided by Morningstar.com.



Index Wars By: John Jacobs
on 1/16/2014

Index Wars: The effect of increased competition on ETF Providers, Pensions and other Institutional Investors. As long as investors continually look for new and better ways to invest in, track or beat the market, index providers will continually be challenged to find ways to create better, more robust benchmarks to meet customer expectations. The demand on index providers today is greater than it’s ever been. Top indexers are expected to do more and more, and as a result changes in the industry are necessary to respond to increased investor demands. This has greatly increased competition among indexers and that competition has had a direct effect on exchange-traded funds (ETFs) providers, pension funds and other institutional investors who are focused on passive investing.

Product Brand has More Power

In the past, almost anyone with a computer could create an index. They were relatively simple and didn’t require a lot of functionality. Today, however, index providers are expected to create, calculate and disseminate indexes rapidly with the ability to perform years of back-testing. Customers ranging from ETF providers to institutional investors are looking for full service indexers with sophisticated databases that have the capabilities and flexibility to respond to their growing needs.

Customer demands and priorities are shifting like we’ve never seen.  The index licensing cost component of total expense ratios has continued to decline in financial products over the last several years and ETF providers are increasingly willing to re-evaluate their current benchmarks in search for the best value available. In the early days of ETFs, the index was a key part of a buyer’s purchase decision. Companies such as S&P sold products and people bought ETFs based in large part to the overall brand of the index provider. 

While having a strong index brand is still important to investors, more and more investors are instead focusing on the brand of the product provider (e.g., Vanguard, PowerShares, etc.). Today, the top three ETF/ETP providers – IShares, SPDR ETFs and Vanguard – account for 69.6% of Global ETF/ETP assets, while the remaining providers each have less than 4% market share.1

Since the brand of the index provider is now only a part of what drives the investment decision, ETP providers have the flexibility to choose among multiple index providers offering nearly identical benchmarks. The increased competition is driving down costs, thus reducing expense ratios. Sophisticated index investors are getting smarter and more willing to look at a broader array of offerings as ETF providers share these cost saving measures with their customers.

Indexes are Becoming Commoditized

With increased competition comes the natural commoditization of products and certain index segments. Global equities are a great example. Twenty years ago, it was actually quite complicated to find a global equities ETP product; however, it is much easier today because every major indexer offers a very similar suite of benchmarks. In the same way, the market has come to expect a consistent set of standards for representing different market sectors so the diversions among index providers are much narrower than they used to be. Twenty years ago, the differences between the offerings of the various index providers were fairly wide. Today, the differences are minimal, making it easier to step from one provider to another, and ultimately reducing the cost of the product. 

Of course there are certain exceptions where index providers differentiate themselves. There are some flagship indexes such as the S&P 500 and the NASDAQ-100 where commoditization has not taken hold. There are also niche indexes, such as a sector family or specific industry-focused indexes like the NASDAQ Biotechnology Index (NBI), where a few indexers have a distinct foothold on the industry.

Pension Consultants Influence: Beyond Asset Allocation

Much of the focus on fees is thought to be on the shoulders of ETF providers, but they are only part of the ecosystem. Pension consultants, who recommend specific benchmarks to their clients, are also starting to weigh in on index licensing costs.  Up until recently, consultants were not as cognizant of how much the people downstream were paying for data. For the asset owners and their managers, this was a hidden cost.  Now, they are realizing that this data cost is a factor in overall investment performance.  Previously, consultants’ primary focus was on their clients’ asset allocation, risk tolerance and risk profile. More often than not, they would then default to the brand name indexes they were accustomed to using.

Today these indexes are receiving more scrutiny based on their pricing. Consultants need to truly understand that every decision matters and which benchmark they choose can make a huge difference in cost. They should be asking themselves the following questions:

  • Are my benchmarks truly reflective of the underlying components of that asset class? 
  • Are they trackable? 
  • Does the provider have a good track record and the ability to track the indexes it offers? 
  • Can I access the data?
  • Is it reliable?
  • What does it cost?

As the index world changes, pension funds and asset owners are going to demand more from their consultants when they walk in the door with their recommendations.

A More Informed Industry

The movement to reduce costs is a big change for the indexing industry and one that will likely accelerate over time. The entire industry —ETF providers, asset owners, pension consultants — is becoming more aware of the costs associated with various indexes and is more willing to look at alternatives to reduce these costs. As more investors become aware of the fees they are paying, the pressure will mount.

Not everyone in the indexing industry is going to be able to keep up. We are already beginning to see consolidation and in the next five to ten years the field will likely be further reduced, with only six or seven large indexers and a few niche players remaining in the game.  The mid-size indexers will more than likely disappear due to the effects of price competition. In the end, the main beneficiary from this competition will be the investor since these cost savings are passed on in the form of lower fees and expense ratios.


1Source: ETFGI

Picking the Right Index By: John Jacobs
on 1/13/2014

Stepping up to the plate to take your first swing at ETF investing has never been simpler and more cost effective, but as eager investors approach these products, are the really understanding the differences in in portfolio composition? Index formulation methodology could likely have a much greater impact on bottom-line performance than fee structure over time. Now that we have a fair amount of price history for comparative analysis, the differences in index construction can amount to a sizeable margin of total return over time.

This is precisely why many exchange-traded product providers are setting their sights on challenging the traditional cap-weighted styles for more exotic, alternative, or smart index strategies. However, these innovative strategies still have a big hill to climb, as cap-weighted indexes still control the largest share of assets under management in the ETF universe.

There is no hard and fast rule to index selection, which is why investors need to be more conscious than ever about the options that are available and how to ultimately select an appropriate fund.

The Basics
There are three primary index construction techniques that publishers use to construct the allocation size in an equity-oriented ETF: market capitalization weight, equal weight, and fundamental weight.

Let’s begin with the index blueprint that most investors are familiar with: market-cap weighting sizes constituent securities according to the total market value of their outstanding shares. In a real world example, examining the PowerShares NASDAQ 100 ETF (QQQ), Apple Inc. (AAPL) occupies roughly 12.5% of the fund due to its $500 billion market cap. On the flip side, the smallest holding, F5 Networks (FFIV), only occupies 0.17% due to its much smaller $7 billion market cap.

Quite simply, a cap-weighted index will advance or decline more dramatically in value in response to the changes in market value of larger holdings vs. smaller holdings. One inherent benefit to this style of index composition is that traditionally larger, more established companies will present less volatility than smaller ones.

However, it’s also important to bear in mind that investors who select cap-weighted indexes are essentially disproportionately tilting their equity allocations toward larger companies that can inhibit performance characteristics over the long term. In a recent study by Goldman Sachs Asset Management that examined the stock market over the past 20 years, it was proven that small and mid-cap stocks have outperformed large cap stocks by a fair margin while presenting only slightly higher volatility.**

Using the same scenario, equal weight indexes are often created using the same list of stocks as cap-weighted indexes. However, instead of examining the size of the company, an equal weight index allocates identical proportion amongst all the constituent securities. So, Apple Inc. would carry an identical weight within the index as F5 Networks, which is the goal behind the NASDAQ-100 Equal Weighted Index. At first glance, this type of weighting strategy might seem illogical in relation to the aforementioned cap weighted style, as investors may instinctively want to own a larger share of mature, successful companies. But, it can often be prudent to carry a larger slice of the pie in small and medium capitalization companies in a rising market environment.

Using a relevant 2013 performance comparison, the cap-weighted SPDR S&P 500 ETF (SPY) has gained 28.97%, while the Guggenheim Equal Weight S&P 500 ETF (RSP) is up 31.74%, a divergence of 2.77%. In comparison, RSP carries an expense ratio nearly four times higher than SPY at 0.40%, making for a compelling value proposition even in light of a higher fee structure. Investors should also be mindful that a larger portion of their invested capital is allocated to companies that are smaller in size, which has been known to exhibit higher beta over time.

Relatively new when compared to the other two strategies, the last type of index methodology is a fundamentally weighted group of stocks. These indexes are developed to account for comparable company metrics such as book value, earnings, revenue, or even dividend rates. Companies exhibiting the strongest traits based upon the screening methodology are then assigned the largest weight within the index.

The beauty of fundamentally allocating to companies using performance based metrics is the ability to overweight a company that is currently undervalued by the market, and vice-versa for overvalued examples. It also gives investors the ability to zero in on a specific metric, such as free cash flow, and apply that metric across a single sector. A striking example illustrating the effectiveness of fundamentally weighted strategies could be made using the First Trust Consumer Staples AlphaDex ETF (FXG) and the SPDR Consumer Staples ETF (XLP). FXG is currently up 39.83% year-to-date, while XLP has risen 25.44% through the same time frame, totaling a staggering divergence of 14.39%.

Selection and Application
Choosing the right index for your personal needs doesn't come down to typical investment roadblocks such as size or accessibility, but rather your individual goals and tolerance for volatility. In other words, investors have become accustomed to traditional market-cap weighted indexes due to their long running history. This is precisely why you should ask yourself whether you feel comfortable stepping outside the classical approach to index investing. In reality, you could conceivably pay a higher fee in order to gain the potential reward that the index you choose hits the market's sweet spot.

As demand evolves for more complicated and specific benchmarks, index construction is growing far more complex. Regardless of strategy, it is imperative that investors demand that index providers bring the highest quality, objective, transparent and rules-based indexes to the market. Indexers must ensure that they have the best available data and technology to match the growing complexities, and methodologies must remain open and transparent to allow for optimal tracking by investors, product issuers and traders.

The overarching conclusion that can be drawn from the differences between these three strategies is the universal shift from overweight positions in large well-known names to concentrated positions in smaller, more nimble, or fundamentally sound companies. These traits should immediately appeal to those investors seeking the chance to outperform traditional benchmark indexes, but it will likely come with the cost of increased volatility over time.

Conversely, cap weighted indexes might still be the right fit for investors who believe in the strength of large companies to dominate a specific segment of the market, and don't want to risk the chances of underperforming traditional market barometers. Undoubtedly, the market for alternative index strategies is growing and attracting assets. Educating yourself on the intricacies of these new products and their potential benefits will ultimately strengthen your investment selection process. Performing your own due diligence alongside your individual goals should lead you down the path of picking the appropriate index that meets your unique investment needs.
*Performance data provided by Yahoo! Finance Through November 30th, 2013

*Goldman Sachs Asset Management White Paper “The Case for Mid-Cap Investing” June 2013, p. 2

Published in Forbes.com January 9, 2014

The Future of Dividend Investing By: John Jacobs
on 12/11/2013

Searching for yield in unlikely places has been an effective strategy for investors looking to gain exposure outside of the classic reliable income sectors such as utilities, healthcare or consumer staples.   Social needs have a way of shaping investor demand; and as the ever-burgeoning population of retirees shifts from a growth mentality to an income philosophy, there are several innovative products that could very well shape the future of dividend investing. 

This year, investors were broadsided by rising interest rates.  Principal values of most fixed-income assets have exhibited volatility that we have not seen for decades. And while dividend-paying stocks briefly weakened, they are now back to all-time highs.  With earnings multiples on commonly held dividend stocks now stretched to historically high levels, where are investors turning to satisfy their cash-flow needs while steering clear from inevitable bull traps?

When looking at an investment opportunity to generate an income stream, investors should ask themselves whether that investment can maintain its principle value alongside the ability to grow its distributions over time.  In addition, performing due diligence on the level of volatility the investment has exhibited throughout history will offer a glimpse of what to expect in the event the economy takes a down turn.  

Dividend Growth Over Time

Dividends have accounted for over 40% of total returns over the last 80 years1.  And it has been shown that companies that grow their dividends over time will weather a rising rate environment, and can even thrive in its wake.  A great example of this would be to compare the current 10-year Treasury note yield to the yield on a basket of dividend growth stocks. 

This year we saw a tremendous rise in the 10-year Treasury note yield, which moved from a low of 1.6% to its current level of 2.5%. During that same time frame, the WisdomTree U.S. Dividend Growth Index (DGRW), a broadly diversified basket of dividend growth stocks, has maintained its yield of 2.00%.

If an investor can reasonably say that a basket of stocks will aggressively grow their dividends year-over-year for the next 10 years, the chances of maintaining purchasing power due to inflation are greatly enhanced.   In addition, now is still a great time to invest in dividend growth stocks since payout ratios (or the percentage of free cash flow that is returned to investors) are still very attractive when compared to forward earnings momentum.

Investors seeking a higher yield may consider the PowerShares High Yield Equity Dividend Achievers Portfolio (PEY), which is comprised of 50 stocks selected principally on the basis of dividend yield and consistent growth in dividends.  The current 30-day SEC yield on PEY is 3.53% and it has a larger emphasis on small and mid-cap dividend paying stocks.  Since there are many ways of calculating yield, the 30-day SEC yield is a method specified by the SEC to calculate yield on funds, which then must be posted by the fund provider to create an “apples to apple” figure for investors. PEY is overweight small and mid-cap stocks vis-à-vis a more natural / neutral market-cap weight.

Sector Dividend Investing

A more targeted theme investors might consider when trying to grow income over time would be an allocation to a specific sector, such as large-cap value technology stocks.  The First Trust NASDAQ Technology Dividend Index Fund (TDIV) is designed to include companies that are consistently paying and/or growing their dividends over time.  Many of these companies are currently trading at price/earnings multiples marginally smaller than the general market.   The current 30-day SEC yield of 2.90% from the 87 holdings in TDIV is more attractive when juxtaposed with DGRW’s more broadly diversified mix of 294 holdings.

With the majority of TDIV’s allocations outside interest-rate-sensitive equity themes, its constituents aren’t as dependent on debt issuance as other income sectors.  Investors may ultimately be better positioned to endure a rise in long-term interest rates, without borrowing costs eating into profitability. 

Often times sector investing can enhance returns by providing overweight allocation to a segment of the market that offers attractive growth and income potential.  To do this, investors would choose an index that maintains exposure to companies that are actively increasing their returns to shareholders. 

Dividend Investing Through Multiple Asset Classes

Targeted sector strategies aside, a multi-asset approach is another way for investors to gain exposure to a broadly diversified and liquid basket of income producers.  Their popularity is just beginning to gain momentum, with individual and institutional investors seeking a low-cost alternative to traditional balanced mutual fund strategies. 

Breaking the mold of traditional asset allocation, the First Trust Multi-Asset Diversified Income Fund (MDIV) embodies a colorful mix of income-producing assets that offers an attractive yield and opportunity for growth of invested capital.  Its asset allocation framework is designed around five core sleeves, which are currently allocated to: 25% dividend equities, 15% high yield bonds, 20% master limited partnerships, 20% preferred stocks and 20% REITs.  With a 30-day SEC yield of 6.85%, this ETF is allocated to some of the highest dividend paying sectors of the market. 

The inherent feature that is most important to this type of multi-asset strategy has to be its performance in a bifurcated market environment.  As one asset class can often become extended or even overvalued, owning a diversified mix can prove to be a pragmatic risk management tool in a volatile market.

And yet another ETF in this category is the Guggenheim Multi-Asset Income ETF (CVY), which incorporates closed-end funds and an overweight allocation to dividend-paying equities in its mix. 


Part of any successful portfolio management approach is the abundance of choices available to reach a stated goal.  The more tools an investor possesses, the higher the probability their goal will ultimately be achieved.  Although the basic philosophy of dividend investing will always remain the same, the emergence of innovative strategies presents investors with robust value propositions in virtually any market environment.

1 Source: Ibbotson, as of December 31, 2010.

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