This article appeared in the March 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.
Higher yields and diversification using ETFs.
By Toni Case, editor of TheBull.com.au
The trusty dividend payment has been the loyal companion over a period of unpredictable sharemarket returns. It may be a surprise to hear that income and not growth has been the major contributor to equity returns over the past five years. (5.04 % compared to -0.87% using the S&P ASX 200 Accumulation Index)
Income-seeking investors have usually bought shares in the big four banks and other financial institutions, retail giants and listed property trusts. Or they have turned to managed funds such as imputation funds that target listed companies paying strong dividends. Others have opted for term deposits or cash, but over a decade of next-to-nothing earned in interest; this has not been a winning strategy.
Beaten term deposits – even before tax
Over the past 10 years the average dividend yield from Australian equities has beaten returns from six-month term deposits and cash management trusts - even before tax. Take into consideration the tax advantages of receiving franking credits from shares and the balance swings even further in favour of dividends.
(Editor’s note: The Russell/ASX Long-Term Investing Report compares the performance of Australian shares against other asset classes over 10 and 20 years.)
New ETFs target high yield
Now there is an alternative for investors seeking yield via equities - exchange-traded funds (ETFs). Just last year three ETF issuers - Russell Investments, State Street and iShares - launched Australian ETFs for high-yield investing.
(Editor’s note: To coincide with the 10th anniversary of ETFs being listed on ASX, the ASX is launching a national ETF roadshow in capital cities to explain their features, benefits and risks, and how investors can use them in their portfolios).
These new ETFs targeted income-seeking investors who like the idea of buying lower-cost funds that provide diversification and higher yield, and are listed on ASX. Before I summarise each dividend ETF, here is a quick review of how ETFs work.
They are similar to managed funds but trade on ASX like shares. Buying a single income-focused ETF gives exposure to as many as 50 high-dividend shares, and you can sell the ETF in the same manner as selling an ordinary share.
The beauty of an ETF, and similarly with managed funds, is that they provide instant diversification in a portfolio; if your portfolio is laden with resource shares, one ETF, which might hold a basket of dozens of stocks, can begin to correct the imbalance.
The difference between ETFs and managed funds is that ETFs set out to track, or replicate, an index, whereas managed funds aim to beat an index. The manager of an ETF will buy each of the constituent shares of the index at market weight - and the yield received from the ETF should roughly match the underlying index. Which index? ETFs often track different indices, and some issuers design their own index for the specific purpose of tracking it.
ETFs distribute returns from dividends, franking credits, bonus and rights issues, as well as dividend reinvestment plan discounts. These are made on a quarterly, semi-annual or yearly basis and on top of that, investors receive any capital gains and losses made in the portfolio.
Looking to the future
The Russell High Dividend Australian Shares ETF (ASX code: RDV), is a portfolio of about 50-blue chip shares with the largest payout ratios. It tracks the newly created Russell Australia High Dividend Index.
It is one thing to distribute generous dividends today, but is the company likely to follow through in the future? The Russell ETF addresses this issue by using estimated future earnings when finding suitable companies for its portfolio. It targets those with a history of paying dividends, which exhibit dividend growth and consistent earnings.
An attraction of ETFs compared to managed funds is that you know which shares the ETF is holding at any given time. For instance, in mid-February, the Russell ETF (RDV) was holding Commonwealth Bank, BHP Billiton, ASX, and AMP, to name a few, according to its website. Therefore, if you also hold a direct share portfolio that includes some of those, you could tailor it accordingly.
Another attraction of ETFs compared with managed funds is the cost. The annual management expense ratio (MER) of the Russell ETF (RDV) is 0.46 per cent, plus brokerage fees. This compares very favourably to managed funds with MERs in the 2 per cent or more range.
Heavy weighting towards banks
State Street’s SPDR MSCI Australian Select High Dividend Yield ETF (ASX code: SYI), searches for companies with a history of paying increasing dividends. Before fees and expenses, it attempts to closely track the returns of the MSCI Australia Select High Dividend Yield index. It has a fee of 0.35 per cent.
Over half of the fund is allocated to financial companies (but not property trusts), such as Commonwealth Bank, Westpac, ANZ and NAB, and 11 per cent to industrials such as Brambles and Amcor. Clearly, you would want to be fairly upbeat on the outlook for financials with this allocation.
iShares S&P/ASX High Dividend ETF (ASX code: IHD) selects companies that distribute higher-than-average dividends and tries to replicate the performance of the S&P/ASX Dividend Opportunities Index, before fees and expenses. This index tracks high-yielding shares from the S&P/ASX 300 index. The annual fee is 0.3 per cent.
Interestingly, the iShares product restricts the number of companies it buys in each sector, so it cannot be too heavily weighed to financials. This improves diversification. At February 16, the fund had a 20 per cent exposure to financials, 20 per cent to industrials, 20 per cent to consumer discretionary, and 15 per cent to consumer staples.
About the author
Toni Case is the editor of TheBull.com.au, Australia's leading trading and investing site. Each week TheBull's free newsletter offers 18 share tips from more than a dozen leading brokers, tailored share portfolios for income and capital growth, plus investing, superannuation and property strategies. TheBull’s Premium newsletter is a subscription service for serious share and super investors.
For a list of all ETFs/ETCs listed on ASX, visit the ETF/ETC homepage.
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