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The InvestQuest View:

Do note that Futures are complex investment products and are not recommended for retail investors. As Futures are traded on margin, investors should be careful not to overleverage to avoid potential margin calls. The content below was done for our personal investment purposes only.

For savvy investors, S&P 500 Dividend Futures looks like a possible way to build exposure to the broader equity market, with a better risk reward compared to the S&P 500 Index currently in our view.

The S&P 500 2023 Dividend Futures looks particularly attractive, with 25% upside according to Goldman Sachs estimates.

This article details our thoughts on dividend futures. The information and opinions presented in this article is NOT to be relied upon for making investment decisions. Please do your own due diligence before investing.

1) Introduction

With the S&P 500 making new daily highs, investors have been in search for a laggard play. We do think one security stands out as offering attractive relative value – S&P 500 Dividend Futures.

Since the 23rd March market low

• S&P 500 Index returned +67.6%

• while the 2023 S&P 500 Dividend Futures returned +25.6%

Year-to-date (see chart below)

• S&P 500 Index returned +18.1%

• while the 2023 S&P 500 Dividend Futures returned -13.9%

Goldman Sachs had written about the relative value appeal of this derivative instrument as early as 3rd June, again on 24th August and once more in their most recent “US Weekly Kickstart” weekend publication.

In this article, we highlight some of the key points made, supplemented with our own findings.

Source: Bloomberg, retrieved 9 December 2020.

2) What are “S&P 500 Dividend Futures”?

What are Futures Contracts?

According to Investopedia, a Futures contract is a legal agreement to buy or sell a particular asset at a predetermined price at a specified time in the future.

For example, if you are a Brent Crude oil producer expecting to produce 1,000 barrels of oil in December 2021, you might consider locking in the Dec-2021 sales price today, just in case Brent Crude price tumbles in 2021. This can be done by going short a Brent Futures contract expiring in December 2021.

What are “S&P 500 Dividend Futures” Contracts?

Similarly, using S&P 500 Dividend Futures contracts,investors are able to express a view of what the dividend per share of the S&P 500 Index will be like in future.

For example:

• In 2019, the S&P 500 Index distributed US$58.69 dividend per share, implying a dividend yield of 1.82% (based on the index’s 2019 year-end closing price of US$3,320.78).

• For 2023, the S&P 500 Index is expected to distribute $55.05 dividend per share…at least that’s what the Futures market is saying. If an investor thinks that the dividend per share for 2023 should be higher than US$55.05, the investor would go long the 2023 S&P 500 Dividend Futures contract.

The exact definition and trade size of the S&P 500 Dividend Futures contract may be found in Appendix 1.

3) “S&P 500 Dividend Futures” are currently pricing in a decline from 2019’s dividend levels

In the chart below, we show the dividend per share (DPS) for the S&P 500 Index from 2007 to 2019, followed by the DPS implied by the Futures market from 2020 to 2030.

• From 2007 to 2019, the S&P 500 dividend per share as represented by the black line, had increased by a compounded annual growth rate (CAGR) of 6.3%.This includes the period spanning the 2008 Global Financial Crisis.

• From 2019 to 2029, the Dividend Futures market as represented by the red line, is painting a very bleak picture and implying a CAGR of -0.5%.

Source: Bloomberg, retrieved 9 December 2020.

According to Goldman Sachs, the Futures market is overly bearish on S&P 500 dividends. For context, Goldman’s DPS forecasts for 2023 and 2029 are depicted as green triangles in the above chart.

• For 2023, Goldman is forecasting US$69 S&P 500 DPS, 25% above what the Futures market is implying.

• For 2029, Goldman is forecasting US$84 S&P 500 DPS, 51% above what the Futures market is implying. While the headline number looks large, it’s just a 3.65% compounded growth from 2019 DPS levels.

4) Historically, S&P 500 has never experienced dividend declines over 10-year periods

In the below chart, we show S&P 500’s 10-year annualized dividend growth since 1970. For reference, the lowest annualized 10-year dividend growth registered during this period was +2.4%!

• On the left side of the chart, the data point for 1980 will indicate the annualized DPS growth from 1970 to 1980.

• On the right side of the chart, the data point for 2019 indicates the annualized DPS growth from 2009 to 2019.

Source: Bloomberg and IQ computations, retrieved 9 December 2020.

If we pull back the data even further, S&P 500’s 10-year dividend growth has never registered a CAGR of less than +2.2% since 1951, according to Goldman Sachs.

While the past may not repeat itself, we note that the 2029 S&P 500 Dividend Futures contract is implying a -0.5% CAGR between 2019 to 2029. This does seem overly pessimistic to me and it would be the first instance of negative dividend growth over a 10-year period, since S&P 500’s inception.

5) How to Invest? We plan to buy the 2023 “S&P 500 Dividend Futures”

In Section 3, we mentioned that Goldman is forecasting for the 2029 S&P 500 Dividends to be 51% above what the 2029 S&P 500 Dividend Futures contract is currently pricing in. However, Goldman does not advise investors to buy into this Futures contract due to thin trading liquidity.

In their view, the 2023 S&P 500 Dividend Futures contract looks particularly attractive, offering a 25% upside based on their estimates with better liquidity.

• On Bloomberg, the ticker is “ASDZ23 Index”

• On Interactive Brokers, I was able to find this Futures Contract by searching for the ticker “SPXDIVAN”

2023 S&P 500 Dividend Futures is implying a 1.5% dividend yield. As of 8 December market close, the 2023 S&P 500 Dividend Futures was priced at US$55.05, while S&P 500 closed at US$3,702.25. Assuming the S&P 500 Index level remain unchanged till 2023 (a relatively bearish scenario), this implies a 2023 dividend yield of 1.5% (computed by US$55.05 divided by USS$3,702.25).

The chart below shows the S&P 500’s Dividend Yield since 1970. We note that a 1.5% dividend yield would be on the low end historically. As such, we do agree that the 2023 S&P 500 Dividend Futures is relatively cheap now.

Source: Bloomberg, retrieved 9 December 2020.

6) Key Risks to S&P 500 Dividends

US corporate tax hike

According to Goldman Sachs, implementation of Biden’s tax proposal would potentially reduce S&P 500 earnings by 9%, with a likely hit on dividends.

However, with the Senate more likely going in favour of the Republicans, significant corporate tax hikes look less likely.

Banks and Energy sectors

According to Goldman Sachs, Banks account for 8% of trailing 12-month S&P 500 dividends. After the Fed imposed a dividend payout ratio cap this year, two banks (Wells Fargo and Capital One Financial Corp) were required to trim dividends. If the Fed’s dividend test is extended to 4Q2021 (which is not the base case scenario), Goldman estimates that additional banks comprising 1% of S&P’s market cap may also be forced to trim dividends.

Separately, oil majors Chevron and Exxon together account for 5% of S&P 500 dividends. At current oil price levels, Goldman believes that Exxon will face difficulty sustaining its dividend for 2021, without crossing the firm’s debt cap discussed by Management.

The InvestQuest View:

Do note that Futures are complex investment products and are not recommended for retail investors. As Futures are traded on margin, investors should be careful not to overleverage to avoid potential margin calls. The content below was done for our personal investment purposes only.

For savvy investors, S&P 500 Dividend Futures looks like a possible way to build exposure to the broader equity market, with a better risk reward compared to the S&P 500 Index currently in our view.

The S&P 500 2023 Dividend Futures looks particularly attractive, with 25% upside according to Goldman Sachs estimates.

Appendix 1: Description and Lot Size of the S&P 500 Dividend Futures Contract

The exact description of the S&P 500 Dividend Futures Contract is included below, extracted from CME Group’s website.

The S&P 500 Dividend Points Index (Annual) futures contract (SDA) is $250 times the S&P 500 Annual Dividend Points Index with the nearest 11 Decembers available for trading. The S&P 500 Dividend Points Index (Annual) (SPXDIVAN) tracks the accumulation of dividends on an annual basis and resets to zero after the expiration of the leading December contract. The observation period is the prior December contract expiration date plus one trading day, through the contract’s December expiration date.

As the S&P 500 Dividend Futures contract size is 250x of the Dividend Futures Index price, one contract of the 2023 S&P 500 Dividend Futures currently offers a notional exposure of US$13,372.50 (US$55.05 Dividend Index Price x 250).