Navigating the Deluge of Dividend ETFs

11/02/2011 10:15 am EST


John Heinzl

Reporter and Columnist,

They all invest in dividend stocks, but here are some important differences in terms of holdings and risk, compiled by John Heinzl, reporter and columnist for Globe Investor.

It’s a dividend ETF dogfight.

With Bank of Montreal (BMO) recently joining the fray, there are now at least five Canadian dividend ETFs vying for a place in your portfolio—six if you include the actively managed Horizons Dividend ETF (Toronto: HAL).

While more choice is a good thing, it can also overwhelm investors. So today, we’ll highlight the strengths and weaknesses of each of the five passive dividend ETFs.

Joining us is Justin Bender, associate portfolio manager at PWL Capital in Toronto, who has some advice for would-be dividend ETF investors.

"People don’t really understand most of these products," he said. All five ETFs invest in dividend stocks and pay distributions monthly, but "they’re all very different in terms of the holdings and the risks involved."

A general rule of thumb, he said, is to limit dividend ETFs to no more than 40% of your Canadian equity allocation. You might also consider pairing the dividend fund with a large-cap ETF, such as the iShares S&P/TSX 60 Index Fund (Toronto: XIU) or the BMO Dow Jones Canada Titans 60 Index ETF (Toronto: ZCN), he said.

There are a couple of reasons for this, he explained:

  • First, the turnover in some dividend ETFs could create extra taxes in non-registered accounts.
  • Second, some dividend ETFs are tilted toward small-cap stocks, which have higher expected returns, but are more volatile and less liquid than large-caps.

If you can’t decide which dividend ETF is right for you, you can always mix and match to suit your needs, he said.

iShares Dow Jones Canada Select Dividend Index Fund (Toronto: XDV)
Yield: 4%
Management-Expense Ratio: 0.53%
Number of stocks: 30

Pros: Launched in 2005, XDV has the longest track record of any dividend ETF in Canada. Companies must have paid dividends in each of the past five years, and meet tests based on yield, dividend growth, and payout ratio.

Cons: Has a small number of stocks and a high concentration in financials, at 50.5%, with banks accounting for 32%. The methodology should keep turnover low, but many Canadian investors already have enough exposure to banks.

Claymore S&P/TSX Canadian Dividend ETF (Toronto: CDZ)
Yield: 3.16%
MER: 0.67%
Number of stocks: 39

Pros: Better sector diversification than XDV, with the largest weighted industry in the fund—energy—accounting for about 24%, and financials just 13%. Company must have raised its dividend for five consecutive years, setting the bar high.

Cons: The index on which CDZ is based—the S&P/TSX Canadian Dividend Aristocrats index—suffered heavy attrition during the financial crisis, after many companies cut or failed to raise dividends. Risk is magnified by a weighting of about one-third in small-caps.

iShares S&P/TSX Equity Income Index Fund (Toronto: XEI)
Yield: 4.7%
MER: 0.62%
Number of stocks: 75

Pros: Has the largest number of stocks and highest yield of the five. No company can account for more than 5% of the index (compared with 10% for XDV and 8% for CDZ).

Cons: Company merely has to pay a dividend to be considered, with up to 75 stocks drafted from the S&P/TSX Composite in descending order of yield. Sector concentration is a risk, with financials and energy together accounting for about 60% of the fund.

BMO Canadian Dividend ETF (Toronto: ZDV)
Yield: 4.3%
MER: 0.4%
Number of stocks: 51

Pros: Lowest estimated MER, reasonable sector diversification, and higher-than-average yield.

Cons: The only dividend ETF not based on an index, it "utilizes a rules-based methodology that considers the three-year dividend growth ratio, yield, and payout ratio." That sounds good, but Bender said BMO doesn’t disclose enough about its methodology for him to make a thorough assessment. Also, the fund has a bias toward mid- and small-cap companies.

PowerShares Canadian Dividend Index ETF (Toronto: PDC)
Yield: 3.9%
MER: 0.55%
Number of stocks: 45

Pros: Similar to XDV, but with 50% more stocks. Based on the Indxis Select Canadian Dividend Index, which includes companies with stable or rising dividends over the last five years.

Cons: A huge concentration—about 44%—in the Big Six banks.

Yields (projected yields after expenses) and management-expense ratios were provided by the ETF companies.

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