Investors should look to dividend-paying smart beta ETFs

Jun 30th, 2016 | By | Category: Equities

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With rates anticipated to stay low for a while, investors should look to dividend paying exchange-traded funds with a smart beta tilt, say market experts.

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Dividend yield paying ETFs can offer a good return

Speaking at the ETF Strategy Income and Yield briefing yesterday, industry commentators said that dividend yield is king.

Caroline Baron, head of Invesco PowerShares ETF Distribution UK, said that investors should “focus on yield because this is where we are now, but it should have some kind of tilt.”

Data from Bloomberg showed that year-to-date the PowerSharesS&P 500 High Dividend Low Volatility UCITS ETF (HDLV), which has  a total expense ratio (TER) of 0.30%, has seen an 11.59% return, compared to the S&P 500 which has returned 1.31%.

“The need for income is paramount as we move forward in these markets and a low volatility filter helps to manage the risk,” she said.

Baron explained that dividend strategies do well even though they carry risks. However, she warned that investors should be aware of so-called ‘dividend traps’.

Dividend traps are stocks with forecasts of attractively high future dividend payments, but the stocks are generally underpinned by weak fundamentals that are unable to support such payments. The result is often forced trimming or even abandonment of the dividend, as the company is not obliged, as is the case in bond interest payments, to continue paying dividends. These dividend cuts often lead to significant falls in share value, adding a second blow to investors.

James Waterworth, director UK & Ireland ETF Sales at Lyxor Asset Management, said: “High dividend yield isn’t better than dividend yield. Higher forecast dividends have a higher failure rate and suffer the risk of halving in value. It’s best to avoid this trap.”

Instead, investors should consider lower volatility stocks which tend to do better than high risk stocks.

The Lyxor ETF Global Quality Income NTR UCITS ETF (SGQP), which has a TER of 0.45%, has YTD performance of 13.22%. The ETF uses the SG Global Quality Income NTR Index as its underlying, which tracks companies with attractive and sustainable dividends. The strategy recognises that in the long term dividends have dominated equity returns while higher risk has not provided higher rewards.

The benefits of this type of ETF is that it uses dividend yield as the main driver of equity returns and the quality stock screen means the dividends are less likely to be cut.

Waterworth adds that compounding dividend yields can also be good. “When you receive the dividend and then re-invest it you expose it to the power of compounding. While the difference between 3.5% and 5% each year on a one-year basis may seem small it adds up over time.”

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