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Could the country’s first ETF especially for retirees be a little too retiring in its investing approach?

The Vanguard Retirement Income ETF Portfolio (VRIF) was introduced a year ago with a mission to produce reliable monthly income using a portfolio with a 50-50 split between stocks and bonds. Bonds, as all investors know, produce next to nothing in yield lately and have been falling in price for most of the year.

VRIF is part of a growing segment of the exchange-traded fund market that offers investors a fully diversified portfolio in a single product that you buy and sell like a stock. You buy VRIF if your goal is to generate monthly retirement income rather than grow your money.

In that sense, VRIF has been a success. Investors have received 8.7204 cents a unit monthly in 2021, good for a yield of around 4 per cent based on the price early in the year. The fund has attracted roughly $310-million in its first year, which makes it Vanguard’s third-best product launch behind the Vanguard Growth ETF Portfolio (VGRO) and the Vanguard Balanced ETF Portfolio (VBAL).

Still, the experience of the past year shows VRIF is a fairly complex product that requires close attention. Take the payout, for example. VRIF’s monthly distribution is readjusted at the beginning of each year with a target payout of 4 per cent. The past year shows how the yield you actually get depends on when you buy.

The share price at midweek was $27.36, which produces a payout of 3.8 per cent based on 2021 distributions. Because VRIF’s unit price has risen this year, the yield on the monthly payments has fallen a little from January’s level of 4 per cent.

Here’s Scott Johnston, Vanguard’s head of product for the Americas, on how the annual adjustment to the monthly payout works: “When markets increase, we increase the payments a little bit. When markets go down, we lower the payment a little bit. We try to cap that within no more than plus or minus 5 per cent.”

In January, as stock markets surged, the monthly amount increased to the current 8.7 cents a unit from last year’s 8.3 cents, a total of 4.6 per cent.

A controversial aspect of VRIF is its asset mix, which is built on that more or less even split between stocks and bonds. Bonds have been dead weight in 2021 and some investing strategists have suggested holding more stocks.

Mr. Johnston said the portfolio is currently tilted slightly to stocks, with a 52 per cent weighting that compares with 48 per cent for bonds. Nothing more drastic is contemplated to adjust for current conditions. “We absolutely do not chase short-term performance,” he said. “We look at 10-year expected returns.”

VRIF’s total return for the year through Aug. 31 was 7.2 per cent. VBAL, a similar portfolio-in-a-box product, has produced a total return of 8.8 per cent over the same period with a portfolio with a 60-40 split of stocks and bonds. However, VBAL’s yield is just 1.7 per cent.

How does VRIF produce its higher yield? Mr. Johnston said approximately 60 per cent of the payout comes from bond interest and dividends and 40 per cent comes from capital gains generated by the fund’s portfolio manager through the sale of assets.

You can get a feeling for how the distributions are composed by looking on the VRIF product profile on the Vanguard Canada website. A total payout of 36.5 cents a share was made in 2020, with capital gains accounting for 16.5 cents.

Eligible dividends, which get the full benefit of the dividend tax credit in non-registered accounts, accounted for 2.9 cents of the total payout. This low amount reflects the fact the Canadian stocks have a comparatively small weighting in VRIF of 11.8 per cent of the total. U.S. stocks account for 38.9 per cent, which puts a more aggressive spin on the fund than you might expect.

Technology is the top sector weighting at 19.2 per cent, and the top three stocks are Apple Inc., Microsoft Corp. and Amazon.com Inc., albeit in small amounts that account for between 0.6 and 1 per cent of the total portfolio. Another aspect of VRIF’s non-conservative equity exposure is an 11.6-per-cent exposure to emerging markets.

VRIF’s stock symbol suggests how it could be used by investors. Drop it into a registered retirement income fund, or RRIF, and let it turn money accumulated over decades for retirement into monthly income you can live on. Note that the 4-per-cent distribution rate may not cover the full amount of mandatory annual minimum withdrawals from a RRIF.

VRIF is also a candidate for seniors and others who want to generate steady income in a non-registered account. Mind the tax treatment of distributions, though. As noted, a little more than half the payout in 2020 was eligible dividends or capital gains, which benefit from a 50-per-cent inclusion rate in non-registered accounts. The rest was largely classified as other income or foreign income, which includes bond interest and dividends from companies outside Canada. No tax advantages there.

The investment industry has been slow to copy VRIF. One new competitor is the Dynamic Active Retirement Income+ ETF (DXR), which was launched in March and offers a fixed monthly payout generated by a portfolio of dividend-paying common and preferred stocks combined with an options-writing strategy.

There are also a few ETFs with an explicit mandate of paying monthly income generated by a diversified portfolio. One of the ways VRIF differs from these funds is by being proactive about telling investors what the distribution for each year will be.

Oddly, given our aging demographic and strong overall interest in income-focused investing, the incumbent monthly income ETFs have not been notably popular. Example: The 10-year-old BMO Monthly Income Fund (ZMI) has assets of just $113-million.

ZMI’s year-to-date total return was 8.5 per cent and its yield is about 3.9 per cent. A recent fee cut may help – BMO has reduced the management expense ratio to 0.2 per cent from 0.61. VRIF’s MER is 0.32 per cent, not outstandingly cheap but certainly a fair value for the job it does.

VRIF’s success in attracting money from investors is notable in a market where the top five best-selling ETFs of the year to date invest in broad stock indexes, technology stocks and bitcoin. Predictable retirement income has its benefits, even if it’s generated with a portfolio half full of bonds.


A VRIF fact sheet

All about the Vanguard Retirement Income ETF Portfolio, which has just reached its first birthday.

Basics

Who: Aimed at seniors looking to generate monthly income from retirement savings

What: A portfolio of Vanguard ETFs designed to pay a set amount of income each month

Why: A simpler, more convenient alternative to choosing individual stocks and bonds to generate income

When: Launched Sept. 9, 2020

Where: Buy it through any broker, online or full service, or trading app

Next level

Payout: This year’s monthly payout of 8.7204 cents a unit works out to 3.8 per cent based on the midweek share price of $27.36.

Fee: The management expense ratio is 0.32 per cent and it includes the cost of the underlying ETFs.

Year-to-Aug. 31 total return: 7.2 per cent

Assets: $306-million

Asset mix: 52 per cent stocks, 48 per cent bonds

Top three holdings: Vanguard Canadian Corporate Bond Index ETF at 24.6 per cent; Vanguard U.S. Total Market Index ETF at 20 per cent; Vanguard FTSE Developed All Cap ex North America Index ETF at 19.2 per cent

Top three sector weightings: Technology at 19.2 per cent; financials at 16.4 per cent; consumer discretionary at 14.1 per cent

Competition: Funds with an explicit mandate of generating monthly income with a diversified portfolio include the iShares Diversified Monthly Income ETF (XTR), the BMO Monthly Income ETF (ZMI), the Purpose Monthly Income Fund (PIN).

Source: Vanguard Canada, National Bank Financial

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