A Compelling Shareholder-Yield ETF

Cambria Shareholder Yield ETF SYLD is a compelling value strategy that targets stocks making large cash distributions relative to their price. Most strategies that do that focus exclusively on dividends. However, dividends are only part of the picture. In fact, share repurchases have overtaken dividends as the primary way that firms distribute cash to investors. This fund takes a holistic view, accounting for cash returned to shareholders through dividend payments, net share repurchases, and debt repayment.

In theory, investors should be indifferent between whether a firm reinvests its cash or distributes it to shareholders. What matters the most is the price paid relative to future free cash flows. This strategy and most that focus on dividend yield tend to favor stocks trading at low prices relative to their current cash flows. Historically, that type of value tilt alone has been a good bet, as stocks trading at lower valuations have tended to offer higher returns than their more expensive counterparts.

Yet there are at least three reasons to favor value stocks that make large distributions to their shareholders: 1) Corporate managers who hold on to cash may be overly optimistic about their ability to earn better returns on their investments than their shareholders. That's especially true of firms with limited growth opportunities. 2) Shareholder distributions impose discipline on managers by constraining their ability to engage in value-destructive empire-building and acquisitions, forcing them to focus on the investment opportunities with the highest expected returns. 3) Buybacks may signal that managers believe their shares are undervalued, though that's not always the case.

Strategy Overview The fund has a good chance to deliver higher returns than the Russell Midcap Value Index over the long term, even though its fee is a bit high for a rules-based strategy. It delivers a deep-value tilt while favoring highly profitable firms committed to returning cash to shareholders.

This is an actively managed strategy, but it is rules-driven. The managers start with U.S. stocks of all sizes and screen for those in the top 20% based on dividend and (net) share buyback yield over the past year. The focus on net buybacks helps the fund avoid stocks that are repurchasing shares only to offset dilution elsewhere (often owing to employee stock compensation). From there, the fund directly screens for value, based on metrics like price/cash flow and price/book value, as well as enterprise value/EBITDA. That said, most stocks that clear the first dividend and buyback yield hurdle tend to look cheap on these metrics, too. The fund also eliminates heavily indebted firms and those that score poorly across a series of other quality metrics.

There's one more shareholder-yield sort, but this time the managers include net debt repayment in addition to dividend and net buyback yield. This reduces exposure to firms that are issuing debt to repurchase their shares or pay dividends, which is not necessarily in shareholders' best interest. To mitigate exposure to stocks with deteriorating fundamentals, the managers filter out stocks with poor momentum and trend.

The managers winnow the final list down to 100 stocks, adjusting the portfolio to prevent sector concentration. Qualifying stocks are equally weighted, which mitigates exposure to firm-specific risk.

Portfolio The resulting portfolio sits firmly in mid-cap value territory, which isn't surprising, as the best values in the market are often found among smaller firms. The fund's equal-weighting approach also contributes to its bias toward smaller stocks. That said, there are some large firms in the mix, including Apple AAPL and Intel INTC.

On most valuation metrics, the fund appears to have a deeper value orientation than the Russell Midcap Value Index. In fact, it has one of the most pronounced value tilts in the mid-cap value Morningstar Category. That's a source of risk but should also help the fund's performance when value stocks are in favor.

Yet, despite its deep-value orientation, the fund doesn't load up on low-quality companies. Historically, its holdings have tended to generate higher returns on invested capital than the constituents of the Russell Midcap Value Index. This isn't surprising, as firms with high shareholder yields tend to have strong free cash flows.

Sector weightings here are quite different from the benchmark. The fund currently tilts toward some of the riskier sectors, including the technology, energy, basic-materials, and consumer cyclical sectors. It holds no utilities or real estate stocks. These sector tilts are a source of active risk that the market may not compensate. However, they aren't static. For example, at the end of July 2020, the fund's weighting in the financials sector (16%) was close to that of the Russell Midcap Value Index. A year earlier that figure was 30%.

The inclusion of recent buybacks and debt repayment in the fund's stock selection approach increases turnover, as those tend to be less stable than dividend payments. Only 60 of the 100 stocks that were in the portfolio at the end of July 2019 were still in the portfolio a year later.

There is less of a stigma associated with reducing share repurchases than there is with dividend cuts. Consequently, share buybacks are most firms' preferred method of making residual cash distributions to shareholders. Firms tend to ramp up their share repurchases when they are flush with cash, not necessarily when their stocks are most undervalued. Similarly, managers tend to reduce buybacks and debt repayment when business isn't as strong.

Performance Although the fund's deep-value tilt has been a headwind over most of its life, it posted slightly better returns than the Russell Midcap Value Index from its inception in May 2013 through July 2020. During that span, the fund slightly outpaced that benchmark by 39 basis points annually, with slightly greater volatility. More favorable exposure to stocks in the energy and industrials sectors helped performance. The higher risk largely owed to the portfolio's sector tilts and more pronounced value tilt.

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