SPDR vs SCHD: The 2023 Performance Gap Unveiled

A notable schism has emerged in the US equity market this year, neatly summarised by the performance of two widely followed exchange-traded funds. The SPDR S&P 500 ETF Trust (SPY) has registered a total return of 5.57% year-to-date, whereas the Schwab U.S. Dividend Equity ETF (SCHD) has fallen by 2.79%. This nearly 8.4 percentage point gap offers a stark illustration of the market’s current character: a narrow, top-heavy advance that is leaving historically reliable strategies, such as dividend investing, trailing in its wake.

The divergence is not a failure of the dividend strategy itself, but rather a consequence of a market environment where returns are disproportionately driven by a handful of mega-cap technology and growth companies. For portfolio managers and allocators, this presents a significant challenge, forcing a re-evaluation of how to achieve genuine diversification when the primary benchmark is itself a concentrated bet.

Anatomy of a Divergence

The underlying mechanics of this performance gap are found in the construction and composition of the respective indices these ETFs track. The S&P 500 is a market-capitalisation-weighted index, meaning its performance is heavily skewed by its largest constituents. In the current cycle, this has meant an immense reliance on a small group of technology-centric behemoths whose valuations have been propelled by narratives surrounding artificial intelligence and durable earnings growth.

In contrast, SCHD tracks the Dow Jones U.S. Dividend 100 Index, which employs a fundamentals-based screening methodology. It selects companies based on criteria such as dividend growth, return on equity, and cash flow to total debt. While this process identifies financially robust firms with a history of returning capital to shareholders, it systematically excludes the very mega-cap growth stocks that have powered the S&P 500. The result is a portfolio tilted towards more traditional, economically sensitive sectors like financials, industrials, and consumer staples, which have faced a more challenging macro-economic backdrop.

A Tale of Two Portfolios

The structural differences are plain to see when comparing the sector allocations. The S&P 500’s significant weighting in Information Technology is the principal driver of its outperformance. SCHD’s methodology leads it to be materially underweight in this area, while holding larger positions in sectors that have not participated in the recent rally to the same extent.

Sector weightings are approximate and subject to change. Data compiled from public ETF disclosures.

This is not a temporary anomaly but the culmination of a multi-year trend. The concentration within the S&P 500 has reached levels that rival previous historic peaks, raising legitimate questions about the diversification benefits of passive index investing. An allocation to SPY is now, to a significant degree, an explicit long position on a very small number of companies.

Implications for Portfolio Construction

The widening gap between these two approaches forces investors to confront a difficult choice. On one hand, aligning with the cap-weighted index has been the winning strategy. The momentum behind the market leaders is formidable, and betting against it has been a punishing trade. Allocators who have remained in traditionally diversified or value-tilted portfolios have likely experienced material underperformance relative to the headline benchmark.

On the other hand, the current market structure presents clear risks. The reliance on a few names makes the S&P 500 vulnerable to idiosyncratic risks affecting any of its largest components. A negative earnings report or a regulatory challenge for one of these firms could have an outsized impact on the entire index. Strategies like SCHD, while lagging in the current regime, offer exposure to a different set of economic drivers and could prove resilient if market leadership were to broaden or rotate.

The key question is whether the current environment is structural or cyclical. If the productivity gains from new technology platforms prove to be as profound as the market anticipates, the dominance of mega-cap growth could persist for years. If, however, economic realities reassert themselves—perhaps through stubbornly high interest rates or a slowdown in corporate spending—the financially disciplined companies that populate dividend-focused ETFs could find themselves back in favour.

A Hypothesis on Reversion

Looking ahead, the most compelling dynamic to watch is not necessarily a rotation from growth to value, but a potential reckoning with concentration risk. The speculative hypothesis is this: the catalyst for a reversal will not be a simple macro trigger like inflation, but rather an “expectations reset” for the market leaders. Should the ambitious growth priced into the top tier of the S&P 500 fail to materialise, the subsequent de-rating could be severe.

In such a scenario, capital would likely seek refuge not just in safe assets like bonds, but in equities that offer tangible cash flows and reasonable valuations. The very characteristics that have caused SCHD to underperform—its lack of exposure to speculative narratives and its focus on established profitability—would suddenly become its primary strengths. The divergence we see today may, therefore, be setting the stage for a sharp and painful reversion for those who have confused a concentrated bull market for a diversified one.

References

FinFluentialx. (2024, October 24). [Post showing year-to-date total returns for SPY and SCHD]. Retrieved from https://x.com/FinFluentialx/status/1840481984830955996