Choosing a Dividend ETF

August 24, 2010

Rob Carrick’s column in The Globe and Mail this Saturday looked at the three dividend ETFs listed on the TSX. Rob asked three bloggers to share their picks: Canadian Capitalist, Million Dollar Journey, and yours truly. I’d like to explain my choice in more detail.

Let’s begin with a review of the three ETFs in question:

Horizons AlphaPro Dividend (HAL) is an actively managed ETF that “invests primarily in equity securities of major North American companies with above average dividend yields.”

Claymore S&P/TSX Canadian Dividend (CDZ) tracks the S&P/TSX Canadian Dividend Aristocrats Index, which focuses on dividend growth. Companies in the index must have raised their dividends in each of the last five years.

iShares Dow Jones Canada Select Dividend (XDV) holds the 30 highest-yielding stocks, though it also screens candidates based on dividend growth and average payout ratio.

I don’t think active management will add value after costs, so that rules out HAL. This ETF currently holds about 10% in cash, reserves the right to hold preferred shares and bonds, and its commentary talks about waiting for the market to reach its targets before deploying that cash. This kind of forecasting is worthless, in my opinion, and doesn’t justify the higher management fee (it’s the most expensive of the three at 0.70%), the inevitably higher turnover, and the perpetual cash drag.

Why not hold two dividend ETFs?

That means the decision comes down to the Claymore and iShares ETFs. My fellow bloggers both chose Claymore’s fund, but I suggested that investors consider splitting their investment between CDZ and XDV. This isn’t because I’m being wishy-washy — it’s because they actually have very different holdings.

Of the 30 stocks in XDV, Claymore’s ETF holds 16 of them, which seems like a lot of overlap at first glance. But the duplication is largely in stocks that make up a small part of each fund. When you look at the top holdings, some big differences emerge.

The iShares ETF is very heavy in banks: overall it’s 60% financials, including 33% in the Big Six banks, which are all in the top eight holdings. That’s a very large concentration in one sector.

Claymore’s ETF holds a more diversified portfolio of 56 stocks, with a much higher weighting in the energy and consumer sectors. While more than a third of its holdings are classified as financials, many are real estate investment trusts (REITs) and income trusts. Banks are a negligble part of CDZ: Scotiabank and TD are the only Big Six names, and together they make up a mere 4% of the fund.

The main reason for this discrepancy is that most banks — despite their high current yields — have not raised their payouts over the last five years and therefore aren’t eligible for the Aristocrats index. While dividend growth is important, does it really make sense for a Canadian income investor to avoid the banks for several more years because they didn’t raise their dividends during the worst financial crisis of our lifetime? If you were assembling a portfolio of dividend payers today, would you ignore the yields of CIBC (5%) and BMO (4.8%) simply because they haven’t raised their dividends every year since 2005?

In my opinion, both of these ETFs have their problems, but they mesh together nicely. The table below shows their average sector weightings. If you held a 50-50 mix, you’d have a nicely diversified dividend portfolio:

XDV CDZ Average
Financials 60% 35% 47%
Telecoms 13% 6% 9%
Utilities 11% 9% 10%
Energy 7% 21% 14%
Consumer Services 5% 14% 9%
Basic Materials 3% 3% 3%
Industrials 2% 9% 5%

One important note: several of CDZ’s top holdings are income trusts. When the new rules take effect next year, the Aristocrats index will boot out any income trust that doesn’t raise its distribution after converting to a corporation. That will change its top holdings considerably, though it won’t change the fact the ETF has very little bank exposure. It will likely just raise the percentage of REITs, utilities and telecoms in the fund. The index is reconstituted every December.

{ 20 comments… read them below or add one }

Money Smarts Blog August 24, 2010 at 10:19 am

In my opinion, all these ETFs are actively managed funds.

The difference is that the Horizons fund keeps their stock picking methodology secret and the other two make their stock picking strategy public.

Financial Cents August 24, 2010 at 10:25 am

Good post. Given the blend both ETFs provide, it is still worth holding an XIU or XIC?

DM August 24, 2010 at 10:48 am

Hi Dan, I would also like to get your view on merits of holding XIU or XIC for broad exposure to Canadian equities and overweighting dividend plays by holding either CDZ or XDV? Seems to me it’s a mistake to get all of one’s exposure to the Canadian equity market through either CDZ, XDV or an overlap thereof as they are narrowly focused on a single asset class. Thoughts?

Canadian Capitalist August 24, 2010 at 11:41 am

HAL was out for me as well mainly because it is tiny and has very low volume. I agree with MoneySmarts that XDV and CDZ track actively-managed indexes as well. I picked CDZ ahead of XDV because it has better diversification and holds more stocks.

I agree with DM. Since dividend payers tend to be “value” stocks, it is not a good idea to get one’s entire Canadian Equity exposure through one or both these ETFs. If I were a believer in overweighting “value” stocks, I’d go with a core holding in either XIU or XIC and complement it with a holding in CDZ or XDV.

Duncan August 24, 2010 at 12:42 pm

Good comparisions! However, I noticed you didn’t mention anything about overall returns – but isn’t that the whole point? Which one is better. The “HAL” hasn’t been around much but the other two sure have.

EF August 24, 2010 at 12:52 pm

Dividend investing shows good returns over the years (see MoneySense art by Norm Rothery). In the US, VIG & SDY are doing quite well. CDZ can be a good complement for someone who has bank stocks or you can add CEW & have the big 5.

Think Dividends August 24, 2010 at 2:48 pm

If you want more banks combine the Claymore Dividend Fund with the Claymore Equal Weight Banc & Lifeco ETF (CEW).

Brian August 24, 2010 at 4:20 pm

Great post Dan. I’ve read a lot about dividend investing in the past, CDZ and XDV are good choices for those who like dividend investing, but don’t want to choose individual stocks.

Mark August 24, 2010 at 8:33 pm

Hi,

Can you write a guide on how to get started with dividend investing? I am currently doing the global couch potato and I would like to get started on dividend investing to generate passive income.

Thanks.

Canadian Couch Potato August 24, 2010 at 9:46 pm

Thanks to everyone for their comments.

@MoneySmarts: I disagree that ETFs with embedded strategies are “actively managed.” There is a distinction between passively tracking a transparent, rules-based index (like XDV and CDZ do) and giving a manager the option of using his or her discretion to pick any North American stock, weight the stocks however they wish, and move in and out of cash based on their market outlook.

@Financial Cents and DM: I agree with CC and would not consider a dividend ETF a core Canadian equity holding.

@Think Dividends: Excellent point. CDZ and CEW would complement each other well in a dividend portfolio.

@Duncan: XDV and CDZ were extremely close in performance last year. CDZ only started tracking the Aristocrats index in mid-2009, so there’s no meaningful period over which to compare the two.

@Mark: I’m not the right person to write a guide to dividend investing. There are several great bloggers doing that (including Think Dividends!). I’d also recommend reading The Single Best Investment, by Lowell Miller:
http://www.mhinvest.com/sbi/sbiindex.html

Slacker August 24, 2010 at 10:43 pm

I’m looking to add a Canadian dividend fund in my taxable account. I think I want to avoid CDZ because of the income trusts and REIT’s, but at the same time, don’t want that much banks…

Money Smarts Blog August 25, 2010 at 8:58 am

“Actively managed” vs “passive” is probably not the right terminology for the point I’m trying to make.

In my (somewhat humble) opinion, passive investing is when a fund is ridgedly based on a published index. Anything else is “active management”.

For example, if a manager comes up with some sort of investing strategy ie “Dogs of the dow” and promises to follow that formula without exception – is that passive investing because the manager won’t be making any more portfolio decisions?

CDZ only investing in companies that have raised their divs for five years – to me that is an active strategy.

Dividends and Asset Classes August 30, 2010 at 12:17 am

ETFs such as XDV and CDZ seem to appeal to investors seeking to fund their retirement based on an income strategy. But is it not taking the investors on a walk away from the principles behind index investing?

Is it a tilt to value or small cap? A look a XDV’s portfolio shows a lot of big banks. CDZ contains less of them and more energy companies. Neither seem to fit particularly well the concept of a tilt to value or small cap. There are better ETFs for that.

What is the plan behind adding XDV and CDZ to an asset mix? Are we giving up on building a portfolio based on a mix of asset classes showing relatively low correlations with one another?

Perhaps we believe that we can beat the market with the addition of XDV and CDZ. Or maybe we want them in the hopes of lowering the volatility, the overall risk of the portfolio. But a tilt to preferred shares, with CPD, might do this better.

So I don’t know. Buy both and get CPD on top, they’re so beautiful!

Canadian Couch Potato August 30, 2010 at 6:45 pm

@Dividends and Asset Classes: You’re right that “dividend stocks” is not a proper asset class. But for income investors, dividend ETFs can play a role in a portfolio. I don’t think that a tilt toward small cap or value stocks is a necessary part of index investing, but if you want to capture these asset classes, then small-cap and value ETFs are indeed a more pure way to do this.

Andrew Hallam September 1, 2010 at 8:15 am

Dan,

Great article! You’ve inspired me to ask something.

Readers of Dan, I’m looking for a subject. I have just a few weeks to finish a manuscript for an investment book that I’m writing for Wiley, and I’m looking for a fairly long term couch potato investor. Ideally, if the person has been using this strategy for five years or longer—with ETFs or otherwise, then I’d love to profile them.

One of my last chapters is a “How to” section. I’m profiling investors in a section I’m calling, “Indexing around the world”. I have an American subject already, and now I’m looking for a Canadian. I’d like to make it real, narrative, and use the investor’s real name. I’m not interested in how much money they have or don’t have—just their journey to couch potato investing, where they were invested before, how they got started etc.

If you’re interested, please give me a shout at investlikebuffett@gmail.com
Thanks!

Andrew

Gord September 3, 2010 at 12:39 am

Very interesting read! You’ve now got me thinking… a great follow-up would be a review of dividend ETFs with international exposure. I’m familiar with the Claymore Global Monthly Advantaged Dividend ETF, but that’s it for TSX ETFs. Are there any others to consider? Or would it be worth considering any outside of Canada and if so, what extra costs are associated with these ETFs?

Khalil November 11, 2010 at 2:44 pm

Questions to Gord and anyone else familiar with Claymore Global Monthly Advantaged Dividend ETF (Code CYH). Your guidance will be appreciated:
1. CYH (MER 0.65) holds two US-based ETFs ( ) which I presume have their own MERs. Does this mean doubling of the MER?
2. Globefund categorizes CYH as CSM (Canadian Small Cap). Since the holdings in CYH are global, is the categorization a mistake, or am I missing something else.

Canadian Couch Potato November 11, 2010 at 3:00 pm

@Khalil: 1. ETFs that hold other ETFs from the same company (and Guggenheim is the parent of Claymore) do not double-charge the fees.

2. If Globefund categorizes CYH as a Canadian Small Cap fund, that’s just a mistake.

Think Dividends December 2, 2010 at 9:49 pm

In the Dow Jones Canada Select Dividend Index, the following three components will be removed: Industrial Alliance Insurance & Financial Ser (Canada, Insurance, IAG.T), Transcontinental Inc. Cl A (Canada, Industrial Goods & Services, TCL.A.T) and Finning International Inc. (Canada, Industrial Goods & Services, FTT.T).

The companies joining the index: BCE Inc. (Canada, Telecommunications, BCE.T), Ag Growth International Inc. (Canada, Industrial Goods & Services, AFN.T) and Bonterra Energy Corp. (Canada, Oil & Gas, BNE.T).

John December 29, 2012 at 12:11 pm

Thank you.

I am just getting back into investing and your comments are very helpful.

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