Until the past few years, investors rarely thought of exchange-traded funds as an income source. Most people saw them as a stock proxy, deigned to generate capital gains as the market moved higher.
But all that has changed. Almost every ETF provider now offers a range of income-oriented funds, with more appearing all the time. In the first quarter of this year, we saw the launch of more than a dozen new income ETFs, including several Dynamic iShares dividend funds, QuantShares MultiAsset Income Allocation ETF (QMY), Hamilton Capital Global Financials Yield ETF (HFY), four Vanguard Bond ETFs, two BMO preferred share ETFs, BMO Canadian High Dividend Covered Call ETF (ZWC) and BMO U.S. Put Write Hedged to CAD ETF (ZPH).
Several of these ETFs look very interesting from a cash-flow perspective. For example, ZPH is currently yielding 6.1 per cent, based on its monthly payouts since February, while ZWC is yielding 6.2 per cent. However, both funds have been quite volatile so far, which will not sit well with conservative investors.
When I select ETFs for readers of my Income Investor newsletter, I look for those with a sustainable payout stream and relatively low volatility. Income investors tend to be older and are more interested in cash flow and stability than in capital gains.
Here are three that I like right now.
Horizons Active Preferred Share ETF (HPR)
Current price: $9.38
Annual payout: 37.34 cents (trailing 12 months)
Yield: 4.07 per cent
Risk: Higher risk
Comments: This is one of the few actively managed preferred share ETFs in Canada (Horizons also has an actively managed Floating Rate ETF while Dynamic iShares recently launched a new one).
At the time I recommended it in the Income Investor, I said it offered good cash flow but warned that we could see a pullback in the share price if interest rates moved higher. In fact, we saw a dip in the price after the units touched a 52-week high of $9.50 in early April, but they have rallied since.
The portfolio is well diversified, and 95 per cent of the assets are rated P-3 or higher. (P-3 is a credit rating from the bond rating services. The range is P-1, or top rated, to P-5.) The management fee is 0.55 per cent.
Summary: This ETF continues to be a good choice for investors who want some preferred share exposure.
BMO Equal Weight Utilities Index ETF (ZUT)
Current price: $18.15
Annual payout: $0.678 (trailing 12 months)
Yield: 3.70 per cent
Comments: This fund slumped badly in December, but since then it has shown strong upward momentum and is now trading above its 50- and 200-day moving averages. That's a reflection of the rally in the S&P/TSX capped utilities index, which is ahead 7.8 per cent year to date.
The portfolio consists of most of the top utility companies in Canada, including Algonquin Power & Utilities Corp., Fortis Inc. and Emera Inc.. Also near the top of the list in terms of weighting are two Bermuda-based limited partnerships that I have been recommending for years: Brookfield Renewable Partners LP and Brookfield Infrastructure Partners LP.
Although the stocks in this fund are interest sensitive, they have not been seriously affected to date by the recent rate increases by the U.S. Federal Reserve and in North American commercial markets. The fund's one-year return to May 31 was 18.4 per cent.
Distributions are paid monthly and are currently running at the rate of 5.6 cents a unit. Most of the payment is taxed as dividend income, with a small amount designated as return of capital. This tax advantage makes the units very appropriate for non-registered accounts.
Summary: Despite the interest sensitivity, this fund is still suitable for risk-averse income investors.
BMO International Dividend ETF (ZDI)
Current price: $22.20
Annual payout: 96 cents
Yield: 4.32 per cent
Risk: Higher risk
Comments: This ETF invests in a yield-weighted portfolio of dividend-paying stocks issued by companies in developed nations outside North America. Stocks are screened using such metrics as dividend growth history, payout ratio and liquidity.
This ETF has done well since the start of the year, moving up more than $2 since January. For the year to May 31, it gained 24.3 per cent, although it showed some weakness in late June as a result of the shift by the Bank of Canada and other central banks to a more hawkish approach.
Somewhat surprisingly, given its political and economic turmoil, Britain holds the No. 1 position in geographic allocation, at 21.1 per cent of the overall portfolio. Australia is No. 2 at 16.4 per cent, followed by France (12.9 per cent), Spain (8.4 per cent) and Sweden (7.6 per cent).
Distributions are paid monthly at the current rate of 8 cents a unit. Most of the payments are fully taxable, so this ETF is best held in a registered plan.
The management expense ratio is 0.44 per cent, and the fund has $233.6-million in assets under management.
Summary: Keep an eye on this one. I see the recent price pullback as a buying opportunity, although we may see more downside before the interest-rate picture becomes clearer.
Disclosure: The author does not own the three ETFs profiled, however he does own Algonquin, Fortis, Emera, Brookfield Renewable and Brookfield Infrastructure.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to buildingwealth.ca. Follow Gordon Pape on Twitter at twitter.com/GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney