If given a letter grade for their performance this year, dividend ETFs might get a D from a lenient investor.
Exchange-traded funds holding dividend stocks have to be ranked among the biggest disappointments of the bear market triggered by the pandemic. It’s shocking how much worse they’ve done than the S&P/TSX composite index.
A prime example is the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ-T), which was down 23.9 per cent for the year through April 27, compared with a loss of 13.2 per cent for the iShares Core S&P/TSX Capped Composite Index ETF (XIC-T). And these are total returns – share-price changes plus dividends.
Big declines in the price of dividend ETFs means big increases in their dividend yield. CDZ had a dividend yield of about 5.3 per cent at midweek, while the BMO Canadian Dividend ETF (ZDV-T) was at 5.7 per cent. A five-year Government of Canada bond had a yield of 0.4 per cent at the same moment, while five-year guaranteed investment certificates peaked in the mid-2-per-cent range for a five-year term.
The comparatively high yields for dividend ETFs reflect the stress being felt by their holdings of dividend stocks. There’s a stereotype of dividend stocks as utilities, pipelines, telecoms, railroads, banks and other blue-chip pillars of the economy. But the dividend-paying universe as reflected in dividend ETFs is much broader. It includes many medium-sized and small companies, some in cyclical sectors such as energy, that are faring poorly right now.
The number of companies cutting or suspending dividends is long – you can catch up here. A slow ramping up back to normal levels of economic activity would mean more dividend cuts by companies forced to conserve cash.
If you buy a dividend ETF today, it’s quite possible that the amount of cash paid monthly will decline over the next year. Keep that in mind if you are mainly focused on dividends for income. But if you’re a total-return investor seeking both growth and dividends, then dividend ETFs offer a bigger opportunity to buy low than ETFs tracking the broader Canadian market.
-- Rob Carrick
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Ask Globe Investor
Question: For an interlisted stock such as Royal Bank of Canada (RY) that trades on both the Toronto Stock Exchange and New York Stock Exchange, if I believe the Canadian dollar is going to fall to about 60 US cents because of the pandemic, would it make sense to buy Royal Bank on the NYSE to profit from the change in the exchange rate?
Answer: No. Presumably what you are suggesting is that, when you sell Royal Bank and convert the U.S. dollar proceeds back into (cheaper) Canadian dollars, you’ll come out ahead. But you are only looking at one side of the currency impact.
Let’s assume, for simplicity, that Royal Bank’s share price will remain more or less steady on the TSX. If your currency prediction is correct and the Canadian dollar falls then – all else being equal – Royal Bank’s share price on the NYSE will also have to fall. Why? Well, the flip side of a falling Canadian dollar is a stronger U.S. dollar, and investors would now need fewer U.S. dollars to purchase a share of Royal Bank. So what you gain from a falling Canadian dollar you lose in Royal Bank’s lower share price on the NYSE.
This is a simplified example, but the lesson is that you can’t use interlisted stocks to capitalize on fluctuations in the exchange rate. The currency effects cancel each other out.
But there’s another – more important – reason to buy interlisted stocks on the TSX: You avoid currency conversion costs. Every time you convert Canadian dollars to U.S. dollars, or vice-versa, your broker effectively dings you for roughly 1 per cent to 2 per cent of the trade value by buying or selling the currency at a rate that is favourable to your broker – and not favourable to you. So buy your interlisted stocks at home and save your money.
What’s up in the days ahead
This weekend, John Heinzl looks at four investing lessons from the pandemic, and Rob Carrick reports on how the March stock market crash seems to have sharpened the appeal of digital investing through roboadvisers and online brokers.
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Compiled by Globe Investor Staff