Under the Hood: First Asset Morningstar US Dividend Target 50 (UXM)

August 18, 2012

This post is part of a series called Under the Hood, where l take a detailed look at specific Canadian ETFs or index funds.

The fund: First Asset Morningstar US Dividend Target 50 Index ETF (UXM)

The index: The fund tracks the Morningstar US Dividend Target 50 Index, which was created specifically for this ETF. The methodology screens US companies based on five criteria: expected dividend yield, cash flow/debt ratio, five-year normal EPS growth, return on equity (latest quarter), and three-month EPS estimate revision. To ensure liquidity, all stocks in the index must also be among the top third in average daily trading volume. The top 50 stocks in this screen are then equally weighted in the portfolio (2% each) and rebalanced quarterly.

The cost: The fund’s management fee is 0.60%. Because the fund is less than a year old it has not published its full MER, but expect it to be at least 0.68% after factoring in the Ontario Harmonized Sales Tax.

The details: UXM is designed to give dividend-focused Canadians a one-stop solution for diversifying into the US market. The index is based on the US Income model portfolio that is part of Morningstar’s Computerized Portfolio Management Services (CPMS), popular with fund managers and investment advisers. The fund uses currency hedging to eliminate exposure to the US dollar.

Some of the more well-known companies in the fund include Coca-Cola, Johnson & Johnson, Colgate Palmolive, Chevron, Exxon Mobil, 3M, Pfizer, Merck, Verizon and Caterpillar. At least half are household names, though there are a smattering of lesser-knowns as well.

Unlike several other dividend ETFs, UXM does not screen for companies that have a long record of dividend growth, which I think is right approach. While I understand the appeal of dividend growers, is a company that has grown its dividend for 20 consecutive years—which is necessary to be part of the S&P High Yield Dividend Aristocrats Index—really a better investment than one that missed a couple of increases for legitimate business reasons? This part of the Aristocrats methodology strikes me as arbitrary and backward-looking. As it happens, only seven of UXM’s holdings are on the Aristocrats list.

Dividend-growth strategies are also biased toward older, mature companies, which in the US makes them dramatically underweight in technology and energy. The sector breakdown in UXM, by contrast, is more similar to that of the US large cap market as a whole:

S&P 500 Aristocrats UXM
Financials (incl. REITs) 14.2% 19.1% 10.0%
Energy 11.2% 1.3% 10.2%
Materials 3.3% 10.4% 3.9%
Industrials 10.2% 14.6% 13.7%
Consumer Discretionary 10.8% 11.2% 8.1%
Telecommunications 3.4% 3.3% 6.0%
Information Technology 19.8% 3.2% 10.0%
Consumer Staples 11.4% 19.4% 20.3%
Utilities 3.8% 10.6% 7.7%
Health Care 11.9% 7.1% 10.1%

The ETF was launched in February, so it’s too soon to say anything meaningful about its performance. The fact sheet gives the index yield as 4.59%; however, the ETF’s first two quarterly distributions were $0.0527 and $0.0944 per share. That first dividend does not cover a whole quarter, so if we just annualize the second figure and assume an average share price of $10, that’s a yield of about 3.78%.

The alternatives: UXM’s most significant competitor in Canada is the iShares S&P US Dividend Growers Index Fund (CUD), which tracks the index discussed above. The two funds have the same fee, but as we’ve seen, they have very different holdings. BlackRock has also just launched the iShares US High Dividend Equity Index Fund (XHD), which tracks a different Morningstar index. Although XHD holds 75 stocks, it is cap-weighted and its top 10 holdings comprise more than 60% of the fund.

Bottom line: In my view, UXM is the best choice for dividend-oriented investors who want an ETF that trades in Canadian dollars and uses currency hedging. Its index focuses on fundamental factors without imposing an arbitrary screen for dividend growth, and its equal-weighting avoids concentration any single company. As a result, it overcomes many of the flaws of its competitors. However, investors who are willing to accept currency risk can find several lower-cost choices among US-listed ETFs, such as the Vanguard High Dividend Yield ETF (VYM).

Disclosure: I do not currently own UXM in my own portfolio.

{ 17 comments… read them below or add one }

Michel August 19, 2012 at 6:29 am

Good article. I’ve been looking for this ETF for my US accounts although this one would be denominated in CDN dollars. They must have one in US dollars. Good long term ETF. Thanks.

Bernie August 19, 2012 at 2:35 pm

Re: Your mention of Ontario’s Harmonized Sales Tax (HST)
I live in AB where there is no provincial sales tax. The HST does not do justice to non-residents. Would you know if there is any way to recoup HST charges that were collected from out of province residents?

This ETF sounds interesting. Is there a similar ETF based in the US?

Canadian Couch Potato August 19, 2012 at 4:05 pm

@Michel: There is no US-dollar version of this ETF. If you are looking to invest US dollars in a dividend ETF, there are many options, but they will all use quite different strategies.

@Bernie: As I understand it, funds that are domiciled in Ontario have to charge HST and there is no way for investors in other province to recover it. If anyone knows differently, please speak up!

There are many dividend-focused ETFs in the US, but none track this particular index, so I would not describe them as as “similar.”

Andrew August 19, 2012 at 4:53 pm

Another useful summary. I like the equal weight aspect. As far as dividend growth is concerned some of the best dividend growers to watch for come from companies who have recently chosen to introduce their first dividend and the aristocrat index misses these.

I have been looking at similar ETFs because of their potentially lower correlation with the TSX. HAZ the Horizon global dividend ETF has a 2 year correlation with the XIU of only 0.19 and 1 year correlation of zero. I would be interested in the correlation of this ETF as well.
Question: Where is the best place to hold a foreign dividend ETF?

Canadian Couch Potato August 19, 2012 at 9:11 pm

@Andrew: In general, US-listed dividend ETFs are best held in an RRSP. In a TFSA you are not subject to income tax on the gains, but you will still pay the withholding tax on the dividends. In RRSP, you should be exempt from this.

Dan Hallett August 20, 2012 at 9:44 am

On the issue of HST, I know that one of the ETF providers handles it this way.

Unlike mutual fund companies, ETF sponsors don’t have detailed breakdowns of who owns how much of each ETF and where they reside. So a few times annually, the ETF sponsor receives a report (from the transfer agent?) showing a breakdown of how many unitholders in each province. The ETF sponsor then uses that data to estimate the % of assets in each jurisdiction. Accordingly, this determines what % of assets are held by investors in HST jurisdictions. They charge a blended tax rate based on this data and their resulting estimate. They charge this tax rate until the next unitholder report, at which point they estimate a new tax rate.

Canadian Couch Potato August 20, 2012 at 10:04 am

@Dan H: Thanks for this info—I had never heard of this procedure. I guess the idea is that the overall amount of tax collected is approximately accurate, though investors outside of Ontario are effectively subsidizing those in the province.

Que September 3, 2012 at 12:19 pm

Dan, along with anyone else willing to discuss,

I know opinions must differ greatly on this, but when do you think one should convert into a dividend-oriented investor? and how?

Thanks,
Que

Canadian Couch Potato September 3, 2012 at 2:05 pm

@Que: In my opinion, there is never a need to convert to being a dividend-oriented investor. It is perfectly possible to create cash flow to fund one’s retirement using a total-return approach. However, I recognize there are some legitimate reasons to prefer a dividend strategy:
http://canadiancouchpotato.com/2011/01/17/when-does-a-dividend-strategy-make-sense/

CK October 6, 2012 at 10:56 am

When new ETFs get created is the first distribution yield amount almost always skewed? I just received my first distribution from XHD.TO and the yield was around 2.4%. Will this yield % get higher on the second distribution? At that measly yield I’d way rather invest in the S&P 500.

Thanks CP.

Canadian Couch Potato October 7, 2012 at 2:36 pm

@CK: Yes, that does seem to be the case. XHD is barely a month and a half old, and while the ETF pays distributions monthly, the companies in the fund do not. So presumably it will take some time for these payment streams to be smoothed out.

CK October 7, 2012 at 3:01 pm

Thank you CCP!

Darryl February 27, 2013 at 3:46 pm

Hello there,
I often read your posts. Thank you for your work. I’m rather new to handling all of my portfolio but seem to be doing alright. One question about UXM for me is liquidity when buying or selling the ETF. It’s hard to lose a few cents per share on each trade.
Thanks.

Canadian Couch Potato February 27, 2013 at 4:01 pm

@Darryl: Thanks for the comment. You lose a cent or two (or more) per share on any ETF or individual stock, so that’s just par for the course. From what I can tell UXM doesn’t not seem to have an unusually large bid-ask spread. Have you had trouble with it?

Ian April 11, 2014 at 2:53 am

I understand “US-listed dividend ETFs are best held in an RRSP” but what of these ETF’s like UXM that are ETFs on the TSX but hold US dividend stocks?
Is there any disadvantage of holding these in a TFSA?

I was thinking of holding UXM in my TFSA, and possibly VIG in my RRSP
Thoughts?

Bernie April 11, 2014 at 9:58 am

Ian,

You have to pay US withholding taxes on distributions made from any US stock in a TFSA whether they are straight stocks, or ETFs of US stocks. It doesn’t matter that the ETFs are listed in Canada…no breaks on US distributions in a TFSA.

Canadian Couch Potato April 11, 2014 at 10:34 am

@Ian: Bernie is correct, although I should add that the tax treatment of UXM would be the same in an RRSP or a TFSA. In both cases you would lose the US withholding tax on dividends (15%). VIG, on the other hand, would be exempt from US withholding taxes in an RRSP, but not in a TFSA.
http://canadiancouchpotato.com/2012/09/17/foreign-withholding-tax-explained/

So if you plan to hold both of those funds, the decision to hold VIG in the RRSP and UXM in the TFSA is the most tax-efficient.

Leave a Comment

{ 1 trackback }

Previous post:

Next post: