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A stress test for income ETFs: Even those filled with bonds and blue chips can go south on you in volatile markets.

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What we're looking at

Exchange-traded funds that hold a diversified portfolio of blue chip stocks and, often, bonds to generate a flow of monthly income. How well did these funds hold up in the stock and bond market volatility last month, and how well have they done over longer periods?

Our screen

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Yves Rebetez of ETFInsight.ca created a list for us of all diversified income ETFs paying cash monthly, and then ranked them from largest to smallest with total return data for each (includes dividends and share price changes).

What we found

A reminder that even a tame income-focused ETF filled with bonds and blue chip stocks can go south on you in volatile markets.

Let's be clear – all of the funds on our list that have been around for three years have done well on a total return basis. But each had its challenges in the harsh market conditions in May and June.

One issue was a high level of bonds, which investors have relied on heavily in recent years because of their good returns and apparent stability. Now, with interest rates on the rise, bonds are in decline (as rates go up, bond prices go down). This helps explain why the bond-heavy iShares Diversified Monthly Income ETF fell 2.94 per cent in the month of June.

Another problem with diversified monthly income ETFs is their heavy weighting in utility, pipeline and consumer stocks, as well as real estate investment trusts. Almost 20 per cent of the BMO Monthly Income ETF is in utilities and REITs, and another 23 per cent or so is in the hard-hit high yield and emerging market bond sectors. Combined, this ETF's holdings produced a loss of 3.05 per cent in June, according to ETFInsight.ca.

The recent price declines for these ETFs say nothing about their ability to keep making their monthly payments of income. But if you've bought these funds expecting a lack of drama in rough markets, it may be time to reassess.

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