How 'income kicker' combines two different portfolio strategies

An “income kicker” with a “one-two punch” is how Senior Portfolio Manager Brett Hryb described the Manulife Smart Dividend ETF (TSX: CDIV), a fund that combines two different portfolio approaches and focuses on sustainable dividend growers.

It targets performance above the benchmark but Hryb, also Managing Director at Manulife Investment Management, told WP the fund is not trying to focus purely on dividends. 

He said: “When the market is down, this may do a little bit better but possibly not as good as a pure defensive fund. And when the market takes off, we're not going to be as strong as the market, generally speaking. But we are going to keep up with it, unlike other dividend focused companies or stock portfolios that would be left behind because of their pure focus on dividends.”

It’s an approach that suits investors looking for extra income while keeping up with the equity market but who still want to maintain control of risk. While designed to appeal to that income-seeking investor, its appeal has broadened to a bigger group that is also looking for equity exposure. It’s not just focused on defence, dividends and resisting market moves, investors are also participating in the market while still getting a good dividend yield.

To understand the fund further, and how it differentiates itself, one needs to go back to its genesis. With a background in quantitative active management, Hryb was initially approached to create systematic funds that focused on quality, value and momentum. That was then developed, combining those building blocks into one fund.

So, with his team, he created and optimized funds for both the U.S. and Canadian market. The Manulife product committee’s feedback was, “great numbers, but what’s your differentiating component?”

A few months later, Hryb was at an event with friend and colleague Philip Petursson, Chief Investment Strategist at Manulife Investment Management. Turned out, he’d been developing a strategy for dividends in Canada which he found compelling but was not in an investable format. Hryb worked on that idea with his team, and produced an equally weighted portfolio focused on Canada. The product committee’s verdict? Great numbers but what's your differentiating component?

“Needless to say, hearing this twice over a relatively short period of time was a little frustrating,” Hryb admitted. “But something clicked in that there was a component between the two of these [ideas] that could be merged.

“We took Philips's idea, expanded on creating a high-quality universe, not just looking at dividend yield, but also growth, sustainability, and quality. We then used the optimized funds that we created to weight those individual stocks, so they were now dynamically weighted on their alpha potential.”

Hence, the one-two punch. Testing came back with strong numbers and, this time, the product committee were won over by the idea of combining two portfolio approaches - the high-quality screen before adding alpha as a weighting mechanism, not as a driver. The latter element is further differentiated because Hryb doesn’t look at price momentum; it's too volatile, especially for a marketplace where you're trying to control turnover.

Critically, the ETF emphasises dividend growth over pure dividend payers, which may look great but could have problems behind the scenes. For example, their yield might be high because they took on debt, even though the stock price is collapsing. The key, Hryb said, is sustainability.

“The company has to have a history of sustainable dividends over a long period of time, and a payout ratio within a certain framework. If that payout ratio spikes, we know they're going beyond just the earnings to generate that dividend. And as a result, it'll get kicked out of our universe.”

Driving the ETF – and its U.S. cousins, the Manulife U.S. Dividend ETF (UDIV, hedged, and UDIV.B, unhedged) – is the team’s 90 years-plus cumulative investing experience. They manage C$62 billion across all mandates, constructing solutions that rely on two core themes – research and process. Each member’s deep experience contributes to the quantitative and equity market research, dividend screening, factor optimization, and efficient trading behind the ETFs.

Their bottom-up approach means some of the market fears weighing on investors, like inflation and interest rate risk, are not as pertinent. The ETFs are back tested in different economic environments and are created to not be beholden to “big calls at the top” like a central bank suddenly raising rates.

“We've tried to create something that is agnostic to the broader market,” Hryb said, highlighting the collapse and subsequent rewriting of energy prices. When that happened, the portfolio took on board the information but through the lens of whether those companies could sustain dividends when prices dropped.

He added: “If they were not able to, they were cut from the portfolio. As prices have started to reflate and the capital structures of these companies became a little bit more stable, they started to reintroduce those dividends and increase them to a point where they're becoming attractive targets [again].”

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