Oliver Smith, portfolio manager at IG Group, takes a look at the best dividend ETFs.
Nowadays investors can approach dividends in two distinct ways; either invest in higher yielding ETFs that perform in a similar way to a market cap index (such as the FTSE 100), or by seeking dividend-focused ETFs that offer lower correlation, and thus diversification, from a market cap index.
At this stage in the economic cycle it is the latter which is perhaps more interesting for investors. Dividend focused ETFs tend to avoid growth names, especially tech stocks, which have performed exceptionally well over the past five years and now make up an increasingly sizeable amount of large cap indices. For example the tech sector has expanded to more than 24% of the S&P 500, but yields just 1.2%.
With volatility having picked up markedly since 2017, equity returns should begin to show more dispersion going forwards; country and sector selection will matter much more and dividend strategies could come back into fashion after a period in the doldrums.
In the paragraphs below we highlight six ETFs which offer some diversification from a traditional market cap strategy and can be bought on the London Stock Exchange.
SPDR S&P Global Dividend Aristocrats UCITS ETF (GBDV)
This is a physically replicating ETF that only invests in stocks that have increased their dividend for at least 10 years. It has grown its dividend by an annualised 6% over the past three years, and yields 3.6%. The country allocation is significantly different to market cap weights, with the US (20.0%), Canada (19.7%) and UK (9.4%) making up the top three countries. It holds just 1.8% in tech.
Lyxor SG Global Quality Income ETF (SGQL)
Continuing the global theme, this ETF (developed by SocGen’s Andy Lapthorne) tracks an index which explicitly recognises that dividends, and their re-investment, dominates long term returns. While it looks at size of dividends, it also focuses on dividend quality, eschewing companies with overly leveraged balance sheets, investing in ‘safe but boring’ businesses which should in theory be less susceptible to financial distress.
2017 was a difficult year for it, with the near 12% overweight to traditional telecoms firms posting flat returns in a strong market.
SPDR S&P US Dividend Aristocrats ETF (USDV)
Yield is traditionally quite hard to come by in the US market, but the SPDR S&P US Dividend Aristocrats ETF (USDV) only buys companies which have increased their dividend every year for the past 20 years. Therefore these are mature businesses with progressive dividend policies that have shown a willingness to make payments to shareholders, and they may be more likely to pass on Trump’s latest tax cuts rather than re-invest in their businesses.
BMO Enhanced Income UK Equity ETF (ZWUK)
The FTSE 100 is a high yielding index but ZWUKF enhances the yield further by around 2% through selling out of the money call options on 50% of the portfolio, giving it an estimated yield of 6.3%. Selling call options can limit capital growth, but for investors that forecast less exciting returns for global indices following nine years in a bull market, this ETF could actually modestly outperform the FTSE 100 in a gently rising market.
It is still small in size, but with market-makers pricing an average bid-ask spread of 0.25% it is liquid and easy to trade in and out of. The TER is just 0.3%, making it an attractive alternative to actively managed funds.
WisdomTree Europe SmallCap Dividend (DFE)
This ETF yields 3.6% and weights the securities by forecasted cash dividends, which should avoid value traps. It charges 0.38% and offers a similar return profile to the EuroStoxx 50 mid cap index, but offers much more diversification with more than 400 individual holdings.
The European market is considerably better value than the US and arguably poised for better times ahead with monetary policy more accommodative at this stage in the cycle.
iShares EM Dividend UCITS ETF (SEDY)
A much riskier investment is Emerging Markets equity income, which has certainly had its up and downs in recent years. SEDY offers a 4% yield and has a weighted P/E ratio of just 9x earnings. Taiwan (26%), Russia (16.4%) and China (11.3%) are the largest country weights amongst its 100 stocks which are selected based on having positive 12m EPS and having paid dividends for each of the past three years. A TER of 0.65% is offset to some extent by 9bps of securities lending revenue.