The fifth instalment of the Globe and Mail ETF Buyer’s Guide turned out to be a stress test for exchange-traded funds holding Canadian dividend-paying stocks. It did not go well.
Dividend ETFs are a convenient, cheap, transparent way to acquire a portfolio of dividend-paying stocks in a single purchase. Most pay monthly dividend income, so they’re ideal for retirees and other income-seekers. In non-registered accounts, dividend ETFs provide tax-advantaged income through the dividend tax credit.
But their performance in early 2020 dispels any illusions investors might have about dividend funds holding up better in bear markets. Many dividend ETFs fully participated in the downturn, and then some. This tells us these funds can throw a scare into people who don’t properly diversify their holdings with bonds and cash. In no way are diversified portfolios of dividend-paying stocks a substitute for interest-paying bonds, even in this era of low bond yields.
It’s true that dividend stalwarts in sectors like telecom and utilities didn’t fall as much as the S&P/TSX Composite Index in the market plunge that began in late February. Dividend ETFs hold these stocks in many cases, but they typically diversify into other sectors. Financials, a hard-hit sector in the market decline, are a big holding. The disastrous energy sector is a big factor in many funds as well.
Diversifying across sectors helps dividend ETFs meet investor expectations for capital gains and dividends – total returns, in other words. But it also exposes them to the full effect of bear markets.
Looking ahead, there’s reason to give dividend ETFs some consideration as a way to participate in a stock market rebound. With their portfolios of beaten-down shares, dividend ETFs typically offer a very generous yield. Remember: Falling share prices drive dividend yields higher. Also, dividend ETFs commonly hold blue chip stalwarts that investors will return to in better times.
If you buy dividend ETFs for income, be mindful of the risk that some companies will cut or suspend dividends if we have a sharp economic downturn. In the aftermath of the 2008-09 market crash, some dividend ETFs had to made modest cuts in the amount of dividend income they distributed to investors.
We’ll close out the 2020 edition of the ETF Buyer’s Guide by looking at balanced funds, also known as asset allocation funds, on April 4. The guide has already covered Canadian, U.S. and international/global equity funds, as well as bond funds.
Notes: Market data as of March 18. Returns to Feb. 28. Sources: ETF company websites, Globeinvestor.com
For comparison purposes, the S&P/TSX Composite Total Return had the following returns:
- Year to March 16: – 27.1%
- 3-yr to Feb. 28: + 5%
- 5-yr to Feb. 28: + 4.4%
Here’s a discussion of terms used in this edition of the ETF guide:
Returns: This edition of the ETF guide scraps the usual one-year return data and instead looks at performance from the start of the year through March 16. The point is to focus on the bear market conditions of early 2020. Three- and five-year returns are also shown.
Assets: Shown to give you a sense of how interested other investors are in a fund.
Management expense ratio (MER): The MER is the main cost of owning an ETF on a continuing basis; published returns are shown on an after-fee basis.
Trading expense ratio (TER): The TER is the cost of trading commissions racked up by the managers of an ETF as they make adjustments to the portfolio of investments; add the TER to the MER for a full picture of a fund’s cost.
Yield: Based on the recent pattern of monthly payouts and the latest share price; may reflect payments of dividends and return of capital; check the fund profiles on ETF issuer websites to find out what kinds of income have been contained in distributions in recent years.
Returns: ETF companies show total returns, or share-price change plus dividends or distributions.
Three-year beta: Beta is a measure of volatility that compares funds to a benchmark stock index, which always has a beta of 1.0. A lower beta means less volatility on both the up and down side.
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