Why your dividend ETF may have more risk than you think

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You thought you were buying a dividend ETF.

But what you actually end up with if you bought many of the exchange-traded funds holding dividend stocks is a two-headed sector fund focusing on financials and energy. Together, they account for 80 to 85 per cent of some of the most popular dividend ETFs listed on the TSX.

A lot of investors are wise to the fact that the Canadian market is weak on diversification. The benchmark S&P/TSX composite index is about 37 per cent weighted to financials, with another 20 per cent in energy. But it's a whole other matter to see this sector skew intensified in a type of fund that many people associate with a more conservative type of investing. Sure, you'll find pipelines, telecom and grocery chains in dividend ETF portfolios. But these holdings are overshadowed by the big banks and energy names like Suncor and Canadian Natural Resources.

In this recent column, I looked at how financials dominate corporate bond and preferred share funds, as well as the broader market. But in researching the latest installment of the Globe and Mail ETF Buyers' Guide, I found that financials are an even bigger issue in some dividend ETFs. Almost as importantly, these dividend ETFs have the volatile energy sector as their second-ranked sector.

Dividend ETFs of all types have a had a rough 12 months, but the three- and five year numbers are still pretty good. This applies to well-diversified dividend ETFs as much as the ones loaded with financials and energy. Still, investors looking to eliminate risk through prudent diversification may want to look at dividend ETFs that have tamped down their weightings in energy and financials. A few examples:

- Horizons Active Canadian Dividend ETF (HAL): The managers of this ETF (it's not an index tracker) have a total of about 36 per cent in financials and energy; the MER is comparatively high at 0.79 per cent, but returns have been quite competitive.

- iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ): Financials and energy together account for 48 per cent of this popular and well established ETF's portfolio.

- Purpose Core Dividend Fund (PDF): Financials and energy each account for just 12 per cent of this actively managed ETF; a heavy weighting of U.S. stocks has helped push returns ahead of many competitors.