Smart Beta: Income ETFs

In the eighth in our series explaining the different styles investors can add to their portfolios through strategic beta ETFs, Kenneth Lamont talks income investing

Kenneth Lamont 17 January, 2018 | 8:52AM
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Kenneth Lamont: Today I would like to continue our introduction to strategic beta series by taking a look at Dividend ETFs.

As their name suggests, in their simplest form dividend ETFs select stocks which have the highest expected dividend yield. The allure of strong income streams in the current low rate environment has helped them become the most popular strategic beta strategy in Europe, currently hording around a quarter of assets under management.

Beyond simply providing an income, dividends matter because they can be used by managers to signal their confidence in their firms' prospects and can impose greater discipline on their capital-allocation decisions. As such, higher yielding stocks are often seen as being higher-quality and more stable than their peers.

Although a simple approach can be effective, especially when implemented in a diversified way such as with the Vanguard FTSE All World High Dividend Yield ETF (VHYL) – in other cases such as the negatively rated iShares DivDAX (EXSB), the low number of holdings leaves the fund particularly susceptible to dividend traps. In this case high yield can actually signal financial distress, making some of the highest yielding stocks more likely to cut their dividends than their lower yielding counterparts.

To protect against this, some funds go one step further and introduce additional screens to ensure sustainability. The SPDR S&P Dividend Aristocrats (GBDV) series only includes stocks which have shown a consistent pattern of maintaining or increasing dividends for at least 10 consecutive years.

Others such as the Amundi MSCI Europe High Dividend Yield (CD9) adds profitability and other quality screens.

Given the quality attributes connected with high yielding stocks it should not come as a surprise that they are considered defensive and expected to perform best in bear markets.

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.

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About Author

Kenneth Lamont  is a passive funds research analyst for Morningstar Europe.