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Investors Eye ETFs for Dividend Income

Passive investors seeking a regular income stream should be aware that some ETFs do not ensure the constituent companies pay sustainable dividends

Karen Kwok 23 March, 2017 | 2:55PM

It does not matter if you favour active or passive fund strategies – for Morningstar readers, income remains the top priority when choosing components for your portfolio. But analysts are warning investors to look for sustainable yields when picking out funds.

Data from Morningstar found that Vanguard FTSE All-World High Dividend Yield ETF (VHYL) and iShares UK Dividend ETF (IUKD) were among the top 10 most popular ETFs among Morningstar.co.uk readers in February. However, Morningstar analysts warned that these funds do not provide sustainable income over the long term. Vanguard FTSE All-World High Dividend Yield ETF came fourth on the top hits list in February while iShares UK Dividend ETF came ninth.

Unsustainable Dividends

Both Vanguard FTSE All-World High Dividend Yield ETF and iShares UK Dividend ETF are not suitable for investors seeking regular income, Morningstar passive analysts warned, awarding the iShares UK Dividend ETF a Negative rating while the Vanguard FTSE All-World High Dividend Yield ETF has a Neutral Rating.

Companies within the portfolio of Vanguard FTSE All-World High Dividend Yield ETF are less profitable in comparison with other dividend-focused funds, said Morningstar passive analyst Dimitar Boyadzhiev. Therefore Boyadzhiev this could translate into higher probability of capital losses or lower realised income since the companies are more likely to cut their dividends. The ETF tracks the highest-yielding segment of the FTSE All-World Index, which does not evaluate the ability of its constituents to sustain their dividend payments.

Boyadzhiev has a positive view of Vanguard’s management team and competitive pricing, however the lack of sustainability makes the fund vulnerable to capital losses.

iShares UK Dividend ETF offers exposure to 50 UK stocks with the highest one-year forecast dividend yield. Simply selecting the highest-yielding stocks can be risky because some high-yielding stocks may be companies with poor fundamentals whose stocks are trading at low prices, reflecting the fact that the company may be in trouble, said Hortense Bioy, director of European passive fund research with Morningstar.  

“This fund has a below-average investment proposition that will likely continue delivering inferior returns over the long term. We have therefore awarded this fund a Morningstar Analyst Rating of Negative,” said Bioy.

Dividend-paying stocks tend to outperform in stable or declining-rate environments but struggle when rates are on an upswing, said Bioy. When rates rise, a company's cash flow must be discounted at a higher rate. All stocks are affected, but if the economy is booming, stable dividend-paying stocks will not generate as much investor demand as riskier stocks from cyclical and speculative sectors, Bioy added.

Will the US Stock Rally Last?

The Gold Rated Vanguard S&P 500 ETF (VUSA) has topped the most popular ETF list among Morningstar.co.uk readers since November last year, following the outcome of the US Presidential Election. Investors also looked at ETFs that track other developed market indices. The Silver Rated Vanguard FTSE All-World ETF (VWRL), Vanguard FTSE 100 ETF (VUKE), iShares Core FTSE 100 ETF (ISF) and the Silver Rated iShares Core MSCI World ETF (SWDA) proved popular among readers in February.

From the election to the end of December 2016, nine out of eleven equity sectors within the S&P 500 traded higher, with value cyclical stocks being the largest beneficiaries as President Donald Trump’s policies were interpreted by many as a shift from monetary policy to fiscal policy, said Fatima Khizou, analyst with Morningstar.

However, this week S&P 500 saw their biggest fall since October, down 1.2%. Morningstar readers, however, look to take profits from the rally by investing in S& 500 tracking ETFs, with Vanguard S&P 500 ETF among Morningstar.co.uk readers’ favourites.

Morningstar analysts also like this fund, saying this ETF is one of the best in its category.

“The Vanguard S&P 500 ETF offers broad and diversified exposure to US large-cap stocks by tracking the S&P 500, the most oft-cited proxy for the US equity market,” said Bioy.

Passive investors also sought gold exposure as well, as the price of yellow metal has been up from the bottom level in December to $1257.32 in February by 11.3%. ETFS Physical Gold (PHGP) and iShares Physical Gold ETC (SGLN) came fifth and seventh on the most clicked ETF list in February. The Silver Rated iShares Corporate Bond ETF (SLXX) came tenth on the list.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
ETFS Physical Gold GBP9,154.33 GBX-1.53-
iShares Core £ Corp Bond GBP Dist144.26 GBP-0.13
iShares Core FTSE 100 GBP Dist716.00 GBX-0.14
iShares Core MSCI World USD Acc GBP3,768.00 GBX-0.24
iShares Physical Gold ETC GBP1,881.50 GBX-1.26-
iShares UK Dividend GBP Dist874.25 GBX-0.41
Vanguard FTSE 100 ETF32.15 GBP-1.30
Vanguard FTSE All-World ETF GBP59.43 GBP-0.72
Vanguard FTSE All-World High Div Yld ETF GBP41.48 GBP-1.14
Vanguard S&P 500 ETF GBP35.10 GBP-0.45
About Author Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk