What are we looking for?
Canadian-domiciled ETFs for the income investor
Just shy of 20 per cent of Canada’s population is over the age of 65, according to the latest Canadian census. In other words, one in five Canadians is either very close to retirement or already retired. As retirees, receiving a steady income is a big consideration when investing, especially for people who prefer the management of cash flows be done by the fund (as opposed to via a disciplined redemption schedule). Most investors are already aware of return of capital payments as a method of providing consistent income over time with some tax benefits, largely prevalent in fixed distribution mutual fund products (often denoted by share class nomenclature, such as F6, T8, etc., with the number indicating the targeted distribution yield of the portfolio). However, in the ETF and DIY mutual fund world, a bit more sleuthing is required to look through historical distributions that commonly reflect dividends, coupons and return of capital payments. To this end, today I use Morningstar Direct to help with this search. To begin with, I screened the universe of ETFs and mutual funds available via discount brokerages for those that
- have received a 4- or 5-star Morningstar Rating for Funds, indicating that the fund has historically outperformed respective category peers after fees, on a risk-adjusted basis. Our data shows that although the star ratings are backward-looking, funds that have received 5 stars as a group outperform those that have received 4 stars, 3 stars, etc. in periods after receiving the rating. In other words, it’s more likely that a fund manager with a track record of outperforming peers will continue to outperform in the future.
- have received a Morningstar Quantitative Rating of gold, silver or bronze, isolating funds that Morningstar believes will produce excess after-fee returns in the future, based on our analysis of people (the quality of the management team), parent (the general stewardship of the fund company) and process (the robustness of the investment process).
I then ranked this list on two specific measures:
- the average annual distributions received over the past five years, assuming a fixed $100,000 investment five years ago and assuming no reinvestment;
- the consistency of distributions over the past five years (measured using standard deviation of annual distributions).
In the ranking process, I placed a greater emphasis on consistency of distributions and a lower emphasis on the total amount of distributions. After all, a large distribution isn’t particularly useful for income investors if it doesn’t happen consistently.
What we found
The top 19 ETFs and mutual funds that met the above requirements are listed in the accompanying table, alongside their fees, trailing performance, ratings, inception dates and a calculation of the distributions received over the past five years assuming a $100,000 fixed investment. It’s important for investors to remember that distributions outline how you get paid out, not the total amount of wealth you’ve gained. For this we look to total returns, which are also outlined in the table. Investors are also urged to note the category to which each of these products belong, as funds on this list can cover vastly different asset classes and geographic exposures, which certainly makes a difference in terms of how much risk investors are taking. That said, this list would serve as a great starting point for further research.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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