If you’re an investor in dividend ETFs, you’ve no doubt heard about the Schwab U.S. Dividend Equity ETF (SCHD). If you were to do a straw poll of investors and ask them what their favorite dividend ETF is, I strongly suspect that SCHD would be the winner (and it might not even be close). It incorporates elements of dividend growth, dividend quality & high yield in its selection criteria and, since its inception in 2011, has amassed one of the best track records in the industry.

That is until 2023.

Performance has been miserable and that’s brought out a lot of haters that are focused on short-term performance. That’s led to a flurry of articles, such as the ones below.

To be fair, the overall ratio of favorable to unfavorable articles on SCHD is still positive and I have read a number of articles that have attempted to either explain the fund’s recent poor performance or focused on the long-term over short-term. I don’t expect everyone to have a positive view on any investment, so I’m not at all saying that SCHD is unimpeachable or no negative opinions should be allowed.

I do, however, take issue with a focus exclusively on very short-term performance pictures at the expense of what’s been a long and stellar track record.

I’m not necessarily here to defend SCHD (although it is one of my favorite dividend ETFs), but I do think it’s important to understand WHY it’s underperformed and whether or not those trends will continue carrying forward.

What’s Gone Wrong In 2023?

Broadly speaking, the fund’s investment style and target investment universe have been badly out of favor. What worked so well in 2022, when both stocks and bonds were declining by double digits, has reversed course in 2023. A surprisingly resilient economy and the booming interest in all things AI has brought investors back to tech and growth stocks in droves. The “magnificent 7” stocks have produced the vast majority of stock market gains this at the expense of almost everything else. Anything more defensive, such as dividend stocks, low volatility stocks and value, has found little interest.

That explains why SCHD has lagged the S&P 500 this year, but it’s actually done quite poorly even within its Morningstar category, "Large Value”.

Within its peer group, SCHD ranks in the bottom 10%, lagging its category average by nearly 6%. It’s no doubt a very disappointing year for investors who have come to expect better.

But I see something more important in this chart, which is what frustrates me when I see the negative press for SCHD right now. How about the decade before 2023? Does that count for anything?

For 10 consecutive years, SCHD has essentially been in the top 1/3 of its category in terms of performance. Not just over the entire 10-year period. For EVERY YEAR of the past decade! That can’t and shouldn’t be discounted by investors. Plus, SCHD’s selection methodology is strong! It looks for positive balance sheet fundamentals, a history of paying dividends and overall portfolio quality. These are the kinds of qualities that make ETFs, such as SCHD, a great core addition to almost any portfolio.

That’s why one bad year shouldn’t throw out 10 years of strong performance.

Why Has SCHD Underperformed In 2023?

Let’s move the focus away on the fact that SCHD has underperformed and understand better WHY it’s understand. Breaking down performance into its different risk factors should help us identify the culprit.

This graphic is from Portfolio Visualizer, which uses the Fama-French 5 Factor Model to break down returns.

We can immediately see some pretty big disparities when comparing SCHD to the S&P 500 and other benchmark comps.

• Rm-Rf (market risk factor) - Most of the funds on this list have a very high score here, which means that a lot of their performance is tied simply to the performance of the broader market. SCHD is the outlier. Relatively little of its performance has been linked to the broader market. That’s not a good thing when the big market averages are being led higher by the big mega-cap growth & tech names.

• SMB (small cap factor) - SCHD has experienced an unusually high exposure to smaller companies. That seems quite counterintuitive given that the ETF consists almost entirely of large-cap stocks. Admittedly, I don’t fully understand why this is happening, but the impact of this factor is fairly clear. Small-caps have pretty consistently underperformed large-caps this year and that’s been a drag on performance.

• HML (value factor) - The fund’s focus on balance sheet quality and fundamentals (or just about any fund really that focuses on these characteristics) tends to tilt much more towards value than growth. Strangely, this factor breakdown tells us that SCHD has actually been underexposed to the value factor. There’s little about the fund’s current allocation (five sectors have weights of 10%, which includes tech, but the others are industrials, healthcare, financials and consumer staples) that suggests a growth tilt, but the numbers appear to bear it out when broken down to the holding level.

• RMW (profitability factor) - This one finally makes sense. SCHD has been much more exposed to the quality factor, even more so apparently than the iShares MSCI USA Quality Factor ETF (QUAL). With quality performing comparatively well this year, this has probably helped with returns.

• CMA (conservative investment factor) - Another factor that intuitively makes sense. The focus on dividend stocks has made SCHD more conservative than the broader market, which probably hasn’t necessarily been a good thing in 2023.

It’s difficult to explain this behavior. An all large-cap portfolio with a small-cap tilt? A heavily value oriented portfolio with more exposure to growth? Perhaps some of this can be attributed to the short time frame being used to measure performance, but this is seemingly one of those cases where up is down and left is right.

If we look at longer-term factor attribution, we see more of what we’d expect.

There’s a modest underexposure to small-caps and overexposures to value, profitability and conservative investment. Again, exactly what you’d expect from an ETF, such as SCHD.

Conclusion

It’s just been a really wonky year for SCHD. Its performance in 2023 is a true outlier and the drivers of its performance are completely counterintuitive to what’s happened in the past.

For a fund that’s had years of stellar performance based on a very solid security selection strategy, we can’t overweight the behavior of one off year. Even the best strategies have their off years and SCHD is no exception.