If things keep up the way they're going, there could soon be as many dividend ETFs as dividend stocks out there.
A U.S. firm called WisdomTree alone has issued 32 exchange-traded funds focusing on dividends, and competitors like Barclays, Claymore, First Trust, PowerShares and Vanguard have another dozen and a half or so listed on North American exchanges. "I can't believe how many dividend ETFs have come out recently," said Tyler Mordy, research analyst at Hahn Investment Stewards & Co., an asset manager that uses ETFs to build portfolios.
Investing in companies that pay dividends is the essence of sound investing, while ETFs are a highly efficient way to get broad exposure to stocks and bonds (they're index funds that trade like stocks). Can dividends and ETFs work together to the investor's advantage?
The answer is yes, but with the following four reservations.
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1. Product clutter. The richer the selection, the harder it is to locate the fund that's right for your needs.
2. Cost. Ownership fees can chop your returns by a 0.5 of a percentage point on average, which is considerable when you look at how much dividend ETFs are yielding these days.
3. Lack of diversification. Some U.S. and global dividend ETFs are loaded with financial stocks, which have a heightened risk level right now because of problems radiating out of the U.S. subprime mortgage market.
4. Overdiversification. Uber dividend stocks that raise their quarterly payouts on a regular basis may be mixed in with sluggards that infrequently boost their dividends.
The main reason to consider dividend ETFs is that you can get exposure to Canadian, U.S., global and sectoral dividend-paying common stocks in a single purchase that should cost you no more than $5 to $29 at a discount broker these days. The management expense ratios on these aren't as cheap as some ETFs, but they're 75 to 80 per cent cheaper than what you'd pay to own a dividend mutual fund.
One example of a dividend ETF is the iShares Cdn Dividend Index Fund, which trades on the Toronto Stock Exchange under the symbol XDV. This fund's MER is 0.5 per cent and it tracks the Dow Jones Canada Select Dividend Index, which includes all the major banks plus a selection of other stocks such as Manitoba Telecom Services, Russel Metals, Rothmans, TransCanada Corp. and Magna International. The dividend yield is roughly 2.9 per cent.
This fund's main competition in the Canadian market is the Claymore Cdn Dividend & Income Achievers ETF, which has an MER of 0.6 per cent and a yield of roughly 3.2 per cent. Here, we have a good illustration of how investors need to do some digging to make sure they buy the product that suits their needs.
The holdings in the Claymore ETF are about 30 per cent invested in income trusts, which offer a good flow of income but don't have the same tax advantage as pure dividends. The largest position in the fund is Energy Savings Income Fund, a trust with a great record for increasing its cash distributions to unitholders but lacking in the blue-chip credentials of the typical dividend stock.
Another issue investors have to investigate is diversification. "I would say the sector allocation on dividend ETFs in the probably the No. 1 thing to look for," Mr. Mordy said. "We're getting a lot more alert about what's underneath ETFs these days."
The Claymore fund has 58 per cent of its assets in financials and about 17 per cent in energy and materials. The iShares fund is 49 per cent weighted in financials and 11 per cent in energy and materials. It also has a 14-per-cent weighting in telecom services stocks (they don't show up in the Claymore fund at all), which are conservative but not great dividend growers.
Diversification is at least as much of an issue with global dividend ETFs. Mr. Mordy said the U.S.-listed PowerShares High Yield Equity Dividends Achievers Portfolio has about half of its assets in small-size stocks, which are more volatile than big blue chips, and its financial weighting of close to 63 per cent compares with 20 per cent for the S&P 500. "With the credit crunch continuing in the U.S. and spreading globally, our firm has been heavily underweight financials since the middle of last year," he said in an e-mail.
The smart way to approach dividend investing is to focus on stocks that regularly increase their quarterly payouts, rather than on stocks with the highest dividend yields. Rising dividends tend to propel a company's share price steadily higher over time, and they provide a rising yield on your upfront investment.
Dividend ETFs are a viable way to pursue dividend growth investing, but some funds are better than others. For example, you'd want to avoid funds that target high-yielding stocks rather than dividend growers. An example would be the WisdomTree High-Yielding Equity Fund, which has an estimated dividend yield of 3.7 per cent.
Lots of dividend ETFs are based on indexes that use dividend growth as one of several criteria for selecting member stocks. Among them is one of the most popular U.S. dividend ETF by trading volumes, the iShares Dow Jones Select Dividend Index Fund, as well as the two TSX-listed dividend ETFs.
If you choose any of these ETFs, you have to understand that you're buying exposure to a collection of stocks that may combine dividend growth standouts with companies that a dividend growth aficionado likely wouldn't bother with. Take the iShares Canadian dividend fund, for example. Its second-largest position is Manitoba Telecom, which has a high dividend yield of around 5.5 per cent but hasn't raised its quarterly payout since 2004.
Dividend growth is the explicit aim of a couple of U.S.-listed ETFs, Vanguard Dividend Appreciation and PowerShares High Growth Rate Dividend Achievers. Consider this pair as yet another example of how dividend-hungry ETF investors need to be aware of what's in their portfolios. The PowerShares fund, which has 44 per cent of its holdings in financials, is slightly under water over the past 12 months; the Vanguard fund, with no more than 22 per cent of its assets in any sector (consumer staples is the top one), has gained about 10 per cent.
If you're looking to add foreign content to your portfolio, it's worth noting that the WisdomTree family of ETFs offers a variety of dividend funds focusing on broad global markets as well as regions such as Europe and the Far East. Larry Berman, chief investment office at ETF Capital Management, said the WisdomTree International Dividend Top 100 Fund (includes dividend stocks from 17 countries) has caught his eye. "It certainly stands out for the yield-oriented investor," he said.
Mr. Mordy said his firm is keeping an eye on the WisdomTree Emerging Markets High-Yielding Equity Fund, which trades on the NYSE under the symbol DEM. "With a juicy dividend yield of almost 6 per cent, DEM is focused on emerging Asia (where we are more bullish long term)."
ETFs and dividends
Canadian market
iShares Cdn Dividend Index Fund (XDV-TSX)
MER0.5%
Estimated yield2.9%
One-year return to Oct. 1811.2%
Top three holdings: CIBC, Manitoba Telecom Services, BMO.
Notes: an option for conservative exposure to Canadian blue chips
Claymore Cdn Dividend & Income Achievers ETF (CDZ-TSX)
MER0.6%
Estimated yield3.2%
One-year return9.7%
Top three holdings: Energy Savings Income Fund, AltaGas Income Trust, H&R REIT
Notes: income trusts account for roughly 30 per cent of holdings
U.S. market
iShares Dow Jones Select Dividend Index Fund (DVY-NYSE)
MER0.4%
Estimated yield3.5%
One-year return0.6%
Top three holdings: Altria Group, FirstEnergy Corp., DTE Energy
Notes: possibly the most heavily traded U.S.-listed dividend ETF
Global
WisdomTree International Dividend Top 100 Fund (DOO-NYSE)
MER0.58%
Estimated yield3.7%
One-year return31.4%
Top three holdings: Telstra Corp., Enel SPA, Westpac Banking Corp.
Notes: stresses high-yielding global stocks
Dividend growth
PowerShares High Growth Rate Dividend Achievers Portfolio (PHJ-Amex)
MER0.6%
Estimated yield1.8%
One-year return-1.6%
Top three holdings: McDonald's, Johnson & Johnson, U.S. Bancorp
Notes: focuses on stocks with the highest 10-year annual dividend growth rates
Vanguard Dividend Appreciation ETF (VIG-Amex)
MER0.28%
Estimated yield1.5%
One-year return9.9%
Top three holdings: Chevron, Exxon-Mobil, IBM
Notes: tracks index of stocks with a history of dividend increases
(source: Gobeinvestor.com, American Stock Exchange, company websites)
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