The trusty dividend payment has been the loyal companion over the past five years of unpredictable sharemarket returns. You may be surprised to hear that it is income, 5.04 per cent annualised, and not growth, -0.87 per cent annualised, that has been the major contributor to equity returns, represented by the S&P/ASX 200 Accumulation Index, over the past five years.
Generally speaking the type of company that pays out sizeable dividends year in, year out is a higher quality, and more mature business. Investing according to this methodology can assist in weeding out the fly-by-night companies and the riskier players.
To date, income-seeking investors have bought shares in the big four banks and other financial stocks, retail giants and listed property trusts; others 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 hasn’t been a winning strategy.
Indeed, over the past 10 years, the average dividend yield on Australian equities has beaten the returns gleaned from 6-month term deposit and cash management trusts. And that’s before tax. Take into consideration the tax advantages of receiving tax-efficient franking credits and balance swings even further in the favour of dividends.
Today there is an alternative on the dance card for investors seeking yield via equities and that’s exchange traded funds (ETFs). Just last year three ETF manufacturers, BlackRock, State Street and Russell Investments, launched Aussie ETFs for high-yield investing.
ETFs are similar to managed funds but they trade on the ASX like shares. Buying a single income-focussed ETF grants you exposure to as many as 50 high-dividend paying stocks – and you can sell your ETF in the same manner as selling an ordinary stock. For the savvier punter, ETFs can be bought on margin, sold at market, limit or as stop orders.
The beauty of an ETF, and similarly with managed funds, is that they provide instant diversification in your portfolio. So if your portfolio is laden with resource stocks, then one ETF 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 stocks of the index at market weight – and the yield you receive on the ETF should roughly match the underlying index. Which index? Well, that’s the confusing part as ETFs often track different indices. Some ETF manufacturers even design their own index for the sheer purpose of tracking it.
ETFs distribute returns from dividends, franking credits, bonus and rights issues as well as dividend reinvestment plan discounts to investors on a quarterly, semi-annual or yearly basis. On top of that you receive any capital gains and losses made in the portfolio.
The Russell High Dividend Australian Shares ETF, which you can find on the ASX website using the code RDV, is a portfolio of about 50 blue chips with the largest payout ratios. The ETF tracks the newly created Russell Australia High Dividend Index.
Its one thing to distribute generous dividends today but is the company likely to follow through in the future? The Russell ETF incorporates this by using estimated future earnings when finding suitable stocks for its portfolio. It targets stocks with a history of paying dividends; that exhibit dividend growth and consistent earnings.
The handy thing about ETFs compared to managed funds is that you know which stocks the ETF is holding at any given time. For instance, as of mid February, the Russell ETF (RDV) was holding Commonwealth Bank, BHP Billiton, ASX, AMP and Downer EDI, to name a few, according to its website. So if you also hold a direct share portfolio with some of these stocks included, you could tailor it accordingly.
The other positive for ETFs, compared with managed funds, is the cost. ETFs charge a yearly management fee for investing your money, at around 0.35 per cent, as well as a bid/ask spread when you buy and sell your ETF of around 22 basis points (0.11%/0.11%). This compares very favourably to managed funds with MERs in the 2-3 per cent range.
State Street’s SPDR MSCI Australian Select High Dividend Yield ETF (the ASX code is SYI), searches for companies that exhibit 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.
Over half of the fund is allocated to financial stocks but not property trusts – such as Commonwealth Bank, Westpac, ANZ and NAB, and 11 per cent to industrial stocks such as Brambles and Amcor. Clearly, you’d want to be fairly upbeat on the outlook for financials with this allocation.
BlackRock’s iShares S&P/ASX High Dividend ETF (ASX code is IHD) selects stocks 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 stocks from the S&P/ASX 300 universe.
Interestingly, the iShares product restricts the number of stocks it buys in each sector, meaning it cannot be too heavily weighed to financials. The fund has 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, as at 16 February 2011. It also offers the iShares S&P/ASX High Dividend (IHD).
An important point to remember when seeking high-yielding products is that dividends paid and dividend yield are not one and the same. Dividends relate to actual dividends paid to shareholders, whereas dividend yield compares the dividend payments to the share price of the stock. So on this measure, if two stocks distribute the same dividends – the stock with the lower share price will boast the higher dividend yield. While this may appear the better investment, it may not be. A dragging share price can sometimes be indicative of darker clouds on the horizon.