The PACER PERSPECTIVE
December 2022

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Dividend Multiplier:
An Innovative Way to
Enhance Dividend Income
Part 1: Dividends and Dividend Futures

- Danke Wang, Portfolio Manager

One of investors' most constant and common concerns is finding ways to increase their yield. The Pacer Dividend Multiplier Strategy provides broad-based equity exposure while aiming to deliver a multiple of the index’s dividend yield.

A fundamental knowledge of dividend futures is helpful in understanding how the strategy works. The following Perspective explores just that. If you already have a firm grasp on dividend futures, feel free to check out Part 2 for a more in-depth look at the construction of our Dividend Multiplier Strategy

Key takeaways:

• Over a 35-year period, more than half of the S&P 500’s total return has come from dividends and reinvestment.
• The S&P 500 total return can be divided into two parts: (1) the price component, tracking changes in the stock prices. (2) the dividend component, tracking the actual dividends paid by S&P 500 companies.
• By using Dividend Futures, an investor can gain exposure to the amount of actual future dividend payments without the impact of price changes in stocks.

S&P 500 Dividend
Let’s start with the basics.

Besides stock price changes, dividends are the other source of equity returns in investors’ portfolios (though dividends are never guaranteed).

In 2021, within the 28.71% total S&P 500 return, 26.89% was due to price appreciation. 1.61% of the returns came from dividends, and the remaining 20 basis points¹ was because of the compounding of dividend reinvestment throughout the year.

In a single year, the price return can dwarf the dividend yield of the S&P 500. Over the long run, however, dividend and dividend reinvestment has been the primary driver of total investment outcomes.

From 1987 through November 2022, the S&P 500’s total return was 3395% cumulatively, while the price return was 1552%. By taking the difference, we can see that more than half of the total return comes from dividends and reinvestment.

(1)Basis Point: One hundredth of one percent

Source: Bloomberg
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU CANNOT INVEST IN AN INDEX

In the past 40 years, we have witnessed a historic secular bull market in bonds as interest rates have been in a downward trend. The S&P 500 dividend yield is also at its lowest level in history. And though rising interest rates and 2022's stock sell-off lifted the 10-year treasury yield above 4% and pushed the S&P 500 dividend yield off its 2021 low, sourcing yield (getting current cash flow from investments) is still a challenging task for income-focused investors.

Source: Bloomberg
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU CANNOT INVEST IN AN INDEX

The harmonic screams of the traditional 60/40 portfolio “not working” may have reached their crescendo this year, considering that in 2022 the “60/40” had its worst performance in 30 years. And despite the recent uptick in rates and yields, it still only offers less than 3% income.

Because of this, investors may turn to other popular income-focused strategies, including dividend stocks and covered calls. But those strategies have their own drawbacks.

For example, a high dividend yield stock strategy may lack growth and share buyback exposure or be too concentrated in specific sectors. Dividend growth funds may also exclude recent dividend-paying companies, particularly those in the Technology and Healthcare sectors. And covered call strategies always force investors to consider the risk of missing the upside beyond their caps.

Against this backdrop, the Pacer Metaurus Dividend Multiplier Strategy (DMS) has emerged as a possible solution in these yield-starved times. The strategy is designed to provide broad-based equity growth exposure while delivering a multiple of the index’s dividend yield. How does it work?

Deconstructing S&P 500 returns
For a portfolio tracking the S&P 500 Index, the investment return can be unbundled into a price component and a dividend component (or the Dividend Strip). The price return over time represents the price component, and the dividend component tracks the actual dividends paid by S&P 500 companies.

Put differently, consider there are two accounts: A and B. Account A includes a portfolio tracking the S&P 500 Index. Over time, dividends received are withdrawn from account A and subsequently deposited into account B. This would result in the market value of account A tracking the S&P 500 price component, while account B’s value reflects the dividend component.

When held in a 1:1 ratio (one dividend component for one price component), the aggregate value of the two should replicate the total return of the S&P 500 (without reinvestment compounding).

Conversely, by applying a different weighting ratio between the components, an investor can re-allocate their mix of exposure between the dividend and price components to meet specific investment objectives. Income-seeking or conservative investors can scale up the dividend portion of their investment returns by holding more of the dividend component relative to the price component.

Institutional investors sometimes use futures, forwards, or swaps to establish the S&P 500 price component. The dividend component is most efficiently created using S&P 500 dividend futures contracts. Dividend futures allow investors to gain exposure to the actual amount of S&P 500 dividends in any given year, irrespective of the price movement of the benchmark index. Dividend futures offer a way to gain exposure to “dividends in isolation.”

Dividend futures
Dividend futures are exchange-traded, cash-settled futures contracts that allow investors to get exposure to the amount of actual future dividend payments. By going “long” on a dividend future, an investor agrees to pay a prespecified price today in exchange for receiving a future payment equal to the actual dividends paid during a specified period – typically a given calendar year. An annual dividend future, as indicated by the name, is based on one year.

For example, on 12/18/2020 (dividend futures always settle on the 3rd Friday), an investor took a long position in the S&P 500 2021 dividend future traded at $56.70. One year later, on 12/17/2021, the settlement date, received the value of the actual S&P 500 dividend, $60.14.

All dividend futures, including those tied to the S&P 500 Index, reference a dividend points index to determine their final cash settlement value. The S&P 500 dividend points index (or DPI) tracks the cumulative amount of S&P 500 dividends paid during the year. At the end of the year, the DPI resets to zero, and the whole process starts again for the following year.

In the earlier example, the dividend points index started to track the cumulative S&P 500 dividends from the close of 12/18/2020 to the close of 12/17/2021. The total dividend amount for the period ended at $60.14 which became the settlement value of the 2021 contract.

For dividend futures investments, the up-front payment an investor must commit is the margin required by the exchange (typically, 3%-5% of the contract’s notional value). For example, if the notional price of the dividend futures contract was $56.70, the margin requirement would be around $2, which serves as collateral at the time of purchase to cover potential losses. That is how dividend futures provide leverage.

The dividend futures position can also be taken without employing any leverage. An investor can pledge the collateral amount equivalent to the notional amount, $56.70, of the dividend futures contract, which would be full collateralization.  

Source: Bloomberg
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU CANNOT INVEST IN AN INDEX

The Pacer Metaurus Dividend Multiplier Strategy (DMS) is based on the concept of the S&P 500 price component and dividend component. By utilizing the S&P 500 dividend futures contract, the strategy aims to scale up the dividend yield of a portfolio tracking the S&P 500 Index.

Next, we’ll dive into the construction of the dividend multiplier strategy and explore how it enhances the portfolio's income-potential.

Dividends Risk: There can be no assurance that a dividend-paying company will continue to make regular dividend payments. The ability for a company to pay dividends is dependent on the economic climate and the companies’ current earnings and capital resources. Changes in economic conditions or a company’s earnings or financial resources could cause a company to reduce its dividend payments or suspend the payment of dividends altogether. The possibility that such companies could reduce or eliminate the payment of dividends in the future, especially if the companies are facing an economic downturn, could negatively affect the Fund’s performance.
The S&P 500® Index is a popular gauge of large-cap U.S. equities and includes 500 leading companies, capturing approximately 80% coverage of available market capitalization.
Covered Call refers to a financial transaction in which the investor selling call options owns an equivalent amount of the underlying security. A covered call is a popular options strategy used to generate income in the form of options premiums.
Futures are derivative financial contracts that obligate parties to buy or sell an asset at a predetermined future date and price.
A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date.
A swap is a derivative contract through which two parties exchange the cash flows or liabilities from two different financial instruments.
This document does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon.Please consult with your financial advisor and tax advisor before investing. This document is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. This document represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. The user of this information assumes the entire risk of any use made of the information provided herein. There is no guarantee this strategy will be successful. The Metaurus US Large Cap Dividend Multiplier Index – Series 400 (the “Index”) is the property of Metaurus Advisors LLC which has contracted with S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC) to calculate and maintain the Index. The Index is not sponsored by S&P Dow Jones Indices or its affiliates or its third party licensors (collectively, “S&P Dow Jones Indices”). S&P Dow Jones Indices will not be liable for any errors or omissions in calculating the Index. “Calculated by S&P Dow Jones Indices” and the related stylized mark(s) are service marks of S&P Dow Jones Indices and have been licensed for use by Metaurus Advisors. S&P® is a registered trademark of Standard & Poor’s Financial Services LLC (“SPFS”), and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”)