Success with dividend ETFs this year depends on how energy-infused they are.
The iShares S&P/TSX Composite High Dividend Index ETF (XEI-T) has a comparatively high weighting of 28 per cent in energy and its year-to-date return through late July was 0.5 per cent on a total return basis. Less energetic is the iShares Canadian Select Dividend Index ETF (XDV-T), with a 5-per-cent holding in oil and gas stocks and a year-to-date loss of 7.2 per cent.
With stock markets showing some vulnerability after last year’s blowout numbers, dividend ETFs offer some appeal as a way to play defence. Each of the nine dividend exchange-traded funds in the 2022 Globe and Mail ETF Buyer’s Guide have outperformed the year-to-date loss of 8.5 per cent for the S&P/TSX Composite Index. But among those nine funds, the level of energy holdings has had a big impact on results.
A defensive asset’s returns are dependent on one of the most volatile sectors in the Canadian stock market? That’s 2022 for you – a year of constant surprises.
Energy stocks can be a problematic holding for a dividend ETF because their quarterly cash payouts have a cyclical aspect to them. An oil and gas company’s dividends offer potential for stability and growth when energy prices are high, but low prices means there’s risk of dividend cuts.
Energy prices have pulled back since early June, but the S&P/TSX Capped Energy Index still had a year-to-date gain of better than 37 per cent. Oil and gas companies are cash-rich and likely to raise dividends and/or buy back shares, which makes them dividend stars for now.
Be careful in making portfolio changes based on this trend, particularly if your primary goal is to generate dividend income. XDV had the highest yield of the nine funds in the ETF guide at 4.3 per cent, according to Globeinvestor. Better performing competitors had yields in the 1.5-per-cent to 3.6-per-cent range for the most part, though XEI did come in at 3.99 per cent.
Long-term investors should be aware that energy stocks will one day be dead weight for dividend stocks. Low oil prices would be a twofold problem – lower share prices and falling dividend payments. Also, a heavy energy weighting in an ETF may come at the expense of financials, which happen to be slumping in 2022. Long-term, financials are a better foundation for a dividend ETF.
Right now, it looks like there’s something wrong with dividend ETFs that have a minimal energy weighting. But their day will come when oil and gas prices fall. You can bank on that happening at some point.
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Rob Carrick