The last word of dividends ETFs

by , 9th July 2018

Income seems to be the holy grail of investing these days and a common place to find it is in dividends. There is good reason to tap into the dividend ETF space, high quality companies that pay sensible and sustainable dividends appear to be more resilient to stressed markets than others.

But, unsurprisingly, when markets get stressed and companies find themselves in choppy waters, dividends are the first thing to go. The popularity of dividend ETFs in the last few years has been dwindling as rate hikes in the US and rising bond yields depress the appeal of dividend stocks and ETFs.

However, one way investors look at getting round problems such as high-yielding stocks cutting dividends is through smart beta dividend ETFs. Smart beta ETFs can also help to capture market inefficiencies which can opportunity to increase portfolio diversification, reduce risk and enhance returns over time.

It’s the biggest growing smart beta ETF area; assets in dividend smart beta ETFs now stand at $193bn, which is 43% of total smart beta assets of $447bn, according to BlackRock.

Providers are also following in their droves.

Last year saw BMO and Fidelity enter the UK ETF market with Quality Income ETFs. Lyxor put out the Lyxor FTSE UK Quality Low Vol Dividend UCITS ETF (DOSH) last year, it tracks an index that includes high quality UK equities that exhibit relatively low volatility and high dividend yields.

This year Xtrackers launched the Xtrackers MSCI World High Dividend Yield UCITS ETF (XDWY)

in April. It has a TER of 0.29% and tracks the MSCI World High Dividend Yield index.

However, with over 1,290 smart beta ETFs in existence globally it’s a saturated market and finding a good, low cost product is no easy task.

For example, returns from the index XDWY tracks lag that of the MSCI World Index which has a three-year annualised return of 8.26%; the MSCI World High Dividend Yield has a return of 6.31% over the same time. An ETF tracking the MSCI World Index is likely to be much cheaper too.

Another fund to look out for is the iSharesDivDax ETF (EXSB). Morningstar says that it’s susceptible to dividend traps because of the small number of holdings. The fund costs 0.31% and has a negative rating from Morningstar analysts.

In fact, Morningstar only rates three high dividend low volatility ETFs with five stars.

Two are listed on the London Stock Exchange – the Invesco S&P 500 High Dividend Low Volatility UCITS USD ETF (HDLV) (it also comes in GBP) – has $225m in AUM and a three-year annualised return of 18.37. It tracks the S&P 500 Low Volatility High Dividend index which measures the performance of the 50 least-volatile high dividend-yielding stocks in the S&P 500 Index.

The other one, listed on XETRA, is the Xtrackers MSCI North America High Dividend Yield UCITS ETF 1C GBP (XDND). It has $185m in AUM and a three-year annualised return of 16.93, according to Morningstar. The index includes securities that offer a higher than average dividend return and pass two dividend sustainability screens.

However, these all come at a cost. HDLV costs 0.30%, while XDND costs 0.39%. Things don’t get much better when you look for higher yielding global exposure.

The S&P Global Dividend Aristocrats UCITS ETF has a three-year annualised return of 11.03. The index measures the performance of the highest dividend yielding companies within the S&P Global Broad Market Index, but it costs a hefty 0.45%.

These are all good enough products if a smart beta approach to dividend ETFs is what you’re really looking for.

However, a friend suggested to me the other day that this search for income is coming at the sacrifice of growing capital.

I didn’t think much of it at the time, but I’m beginning to wonder if they have a point.

Firstly, for an income ETF you’re going to pay a premium over a regular ETF fee: secondly, the dividend tax-free allowance is only £2,000 – the capital gains one is £11,700; and thirdly, dividends are often paid gross and then fees are deducted from the capital.

The last one is a bit of a ball breaker, because by increasing the dividend size (by taking from the capital gains pot), you’re using up the tax-free allowance quicker, which basically means that the investor is paying tax sooner. After using up the dividend tax free allowance basic tax rate payers are looking at 7.5% tax, higher rate payers 32.5% and additional rate payers 39.1%. And are investors aware they are drawing down on their capital?

I don’t know the answer. However, it’s made me suspect that the dividend/income fixation might be an excellent marketing ploy, because in my mind, if you’re going to invest in one of these, then it’s got to perform and be seriously good value for money – and trying to find one of these is no easy task.

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