In January, RBC launched the Quant Dividend Leaders ETFs, a family of dividend-focused funds covering the Canadian, U.S. and international markets. I recently had a chance to speak with Bill Tilford, Head of Quantitative Investments at RBC Global Asset Management, to learn more about the new ETFs:
RBC Quant Canadian Dividend Leaders (RCD)
RBC Quant U.S. Dividend Leaders (RUD/RID.U)
RBC Quant EAFE Dividend Leaders (RID/RID.U)
The funds do not track a third-party index: rather, the portfolios are built using a rules-based methodology. Unlike the popular S&P Dividend Aristocrats indexes, which focus on past dividend growth, Tilford says the RBC ETFs try to be forward-looking. So in addition to screening for stocks with above-average dividend yield, the strategy also looks at three measures of financial strength to determine the sustainability of the dividends.
The first is called the Altman Z-score, which has been used since the 1960s to estimate the probability of a bankruptcy. “It also does a great job of forecasting dividend growth,” says Tilford. The other factors are the volatility of the firm’s return on equity (ROE) and the amount of short interest. “Companies that have higher volatility in ROE are obviously less inclined to increase dividends, or even to sustain them. The short interest on the company is a market-oriented indicator about whether the company is under duress.”
Finally, the strategy looks at current and forward-looking ROE to estimate the likelihood that dividends will grow.
Watching your weight
The next stage in building the RBC dividend ETFs is weighting each of the stocks in the portfolio. Again, Tilford stresses the strategy is designed to look forward. “A cap-weighted index, by definition, is always looking in the rear-view mirror,” he argues. There is no reason to believe that the largest companies will continue their dominance. “When companies exert leadership—like Apple has over the last few years, for example—we know that creates competition. A cap-weighted index will unfortunately suffer because it always assumes an industry leader like Apple will persist.”
The RBC ETFs use a “modified cap-weighting” strategy that tends to underweight large companies and give more influence to mid-cap and smaller stocks, especially those that are more liquid than their market cap might suggest. The specific methodology is kept under wraps, however. “It is transparent to any investor in the sense that you know what we own every day and what the weights are. But the method itself is treated as proprietary.”
Bending the rules
The fund managers may also bend the rules on occasion. “In exceptional circumstances we would review the rules. Those exceptions would have to be situations where it clearly makes sense to override. An obvious one would be an M&A situation developing: clearly the stock’s performance is going to be more influenced by a takeover situation, and the rules won’t know anything about that. So very rarely and selectively we would get involved and adjust.”
There will be some discretion involved in the rebalancing of these funds as well. Like most index funds, these ETFs will be rebalanced quarterly, but not on the customary dates (the last day of March, June, October and December). “We will effectively target mid-quarter,” says Tilford, “so mid-February, mid-May, and so on. This allows us to digest all of the quarterly information, and more importantly, it gets away from month-end or quarter-end rebalancing, which creates extra costs in the market.” (Here Tilford is talking about the front-running that can take place when well-known indexes add or remove companies.) The rebalancing dates won’t be announced in advance.
Nothing passive here
Rather than labelling investment strategies as either passive or active—as though there were only two absolute categories—I think it’s more helpful to place each one along a continuum. I’d put the RBC Quant Dividend ETFs quite far to the active side. There are a lot of rules, they’re created in-house rather than by a third-party index provider, they’re not transparent, and they can be ignored at the discretion of the manager.
Tilford is quite unapologetic in RBC’s marketing material that these ETFs were specifically designed as an alternative to passive investing. “We argue that if you’re building a rules-based solution, who would you rather have? We would argue that active money management provides you a great leg up.”
Bottom line, these funds aren’t a good fit for Couch Potatoes, but they will appeal to dividend-focused investors looking for active management at low cost.
Interesting, thanks for the heads up! I wasn’t aware RBC was entering the ETF space. I like it that these funds go beyond indexing and appear to have higher yields than most dividend based ETFs. In the literature the funds show management fees of 0.39%, 0.39% & 0.49% for RCD, RUD & RID. Any idea what that translates into MERs?
A cap-weighted index doesn’t assume that the largest companies will continue to be the most successful – it just assumes there is no more efficient way of setting weights when you consider all the costs of managing the fund.
@Bernie: As a rule of thumb I usually add 10% to the management fee to account for the blended GST/HST the funds need to charge. So in this case, tack on 4 or 5 extra basis points as an estimate.
I’m always wary if someone claims to have some secret sauce promising higher returns.
On the upside, costs seem to be reasonably low to be a real competitor to incumbent dividend ETFs. If their MERs are markedly lower than that of competitors (e.g. CDZ), this would give them a leg up even if the quant strategy underperformed the index.
Can’t really tell yet with some data (e.g. MER) not yet available.
@Richard: Well said. That argument applies to most criticisms of cap-weighted indexes, and even to the efficient markets hypothesis. No one would argue they’re perfect. The problem is any other solution is almost certain to incur higher costs and other obstacles.
The largest holding is RBC, obviously. Financials are nearly 40% (higher than market).
Not only do they charge you MERs, trading costs in the fund (that’s extra), visible commissions, invisible commisons (spreads), etc, etc, they also want your capital to beef up their ratios! (Similar to BMO’s 6 Banks fund – “equal” weighted since BMO is smaller than the others)
Can I open a bank? I’d like to be in the business.
I think the flaw in this method is that they’re picking stocks where everyone has already agreed that everything about the stock is good. The consequence is that they’re likely to over-pay. Returns in the future will almost certainly lag the index. When you buy the index, by contrast, you buy at least some stocks where people are pessimistic, and there’s therefore some room for upside surprises. I may be wrong, of course. I’ll check back in twenty years to see how they’ve done!
Sean & Roger,
It’s easy to knock a new ETF player especially one that carries a lot of financials in it’s holdings. That said most of the better dividend stocks in Canada are bank stocks and they have very good dividend growth prospects. I wouldn’t consider these ETFs either until they show me some favourable historicals but I refuse to discredit them at this point in their early life. The future returns may or may not outperform the equity indexes, who’s to say. More than a few dividend ETFs do beat the markets.
“A cap-weighted index, by definition, is always looking in the rear-view mirror,”
Does he even understand how markets work? Stocks prices aren’t set by how profitable a company has been in the past, they are set by how profitable the market believes it will be in the future.
I’m not sure where this question might fit, but it is tangentially related.
I’m in a weird situation where I have 2 competing, incompatible scenarios.
I stop working in Sept 2015, head to a cheaper place to live (East Coast, Canada), and try to live off of dividend income.
I continue to work for another 20ish years, and follow some form of coach potato strategy.
Here are some details that may not be so important:
I needed a major rebalance so I went ahead and sold all stocks/etfs/funds across my family’s accounts RRSPs/TFSAs/RESPs and have the following CASH (TDB8150) positions
RRSPs – $275,000
TFSAs – $90,000
RESPs – $45,000
Non-Registered – $50,000
In Scenario #1, I’d also sell a mortgage-free house and net about $500,000 and try to live off dividends from that. I’d try to target 5-6% (is that very unreasonable?)
So, in Scenario #1, I’m looking for “stable” dividend income. Around the time I sold everything, TD had an advisor contact me to come in and talk…no strings attached. I’ve never met with an advisor before, but am fairly clueless what to do if I entered a “retirement mode” and figured why not. He had various ideas, some fee based, some not. I talked up the couch potato strategy etc and of course we wasn’t super impressed. He did point out one fund that must be quite popular for income, (Sentry Candian Income) http://www.theglobeandmail.com/globe-investor/funds-and-etfs/funds/summary/?id=55033 . Now, there must be folks here that can tell me what the gimmick is with this fund. Why do the numbers make this look like it has outperformed pretty much everything over a 10+ years scenario with lower risk? I don’t know enough to debunk why this is not as good as it seems. Obviously the MER is bad, but it has seemingly trounced the index approach regardless. This RBC option seems somewhat similar to me? I’m also curious what other folks are doing once they needed income and stability and if couch potato has a place after “retirement”.
I just rebalance, buy some indexes, and continue to accumulate. I remember reading “Money Logic” when it came out (Milevsky) and it said that the best time to invest a large sum of money is “now”. That said, now that I am all in cash and the markets all being at “highs” I feel anxious about buying in all at once. Is there any more current data/research on this? DCA my way in over the next while? Otherwise, I embrace the contrarian “Buy in May and go away” strategy that no one has ever recommended.
Sorry for the long post!
RW, it sounds like you’ve done well and you have a fair bit of financial security. That’s enough to buy you a modest retirement with above average security or let you explore other options as you continue to grow your assets. Here are a few thoughts on your questions:
– A 5 – 8% yield is high, especially now. You would likely need to buy and then wait for some growth to get that.
– Most people use a 4% withdrawal rate, but it’s very important to note that this is based on research that doesn’t include fees! If you did use that rate, the $500k from selling your house could pay a rent of $1600/month (and that’s not even counting the savings on property tax, maintenance, and insurance if you have any).
– The income fund you mentioned has half of its assets outside of Canada but it’s compared to the Canadian benchmark, which doesn’t tell you anything. Even if it actually did out-perform the index, most funds that post a good performance do not repeat it. It’s also 83% invested in stocks which is a pretty high risk if you’re counting on the income for your living expenses. The one thing that is certain is that the manager will take nearly 3% of your money every year ($26,000 per year). It sure is good for the manager’s and advisor’s income :) There are advisors who will take on clients with assets like yours for half the fee. If this is what you want, look for an advisor with a fairly high minimum asset level.
– If you have an asset allocation that matches your needs for growth and risk, there is nothing to stop you from collecting the dividends and selling off a few shares to create the income you need. Even though this may sound wrong, if the total return is more than your withdrawals the portfolio will still hold up.
– All the research confirms that DCA increases your risk (Vanguard just published another study on it in 2012). It’s like buying a few lottery tickets with a small prize. It may not be a huge risk but if you do it enough times you will lose money.
– When you’re only doing something once in your lifetime you can’t really talk about probabilities because there will only be one outcome for you. The best solution is to determine a safe asset allocation given your assets and needs and go do that. Imagine that your money was 100% invested in stocks last week, and you just decided how much to sell and invest in bonds and other assets. Then you wake up this morning and find out that someone already sold everything and it’s all in cash – would that stop you from buying what you really want? That’s where you are right now. That asset allocation that is right for you should be one that is safe to buy now. If it’s not then it may be too risky for you. However, if you aren’t comfortable with that then doing DCA over 1 – 2 years is certainly not as bad as something like paying a 3% fee.
– People who “buy in May and go away” are too busy making money and enjoying their life to make a lot of noise about their strategy. Their results are much more impressive than their marketing budget.
– Have you considered other choices besides retiring completely or sticking to your current location and career? A little income can replace a lot of assets or just give your portfolio time to grow.
@RW: My suggestion would be to speak with a flat-fee financial planner who can compare your two scenarios and offer unbiased advice about their probability of success. This is not an investment question: it’s a planning question. So I’d recommend you not go anywhere near investment advisors who will try to address your questions by recommending income-oriented funds or other products.
Can anyone figure out the difference between RID’s “Weighted Average Dividend Yield” of 4.92% versus their actual distribution of ($.053×12)/$21.21 = 3.0% ?
I emailed RBC. They stated what we know already, i.e. Mgmt. Fee @ 0.49% + HST @ 13% = 0.553%; Plus foreign withholding tax (approx. 12%? = .12 x .0492 = .0059) .
Total so far = .0492 – .00553 – .0059 = .0377 = 3.77%.
The only other thing they mentioned was “timing” . But the $.053 monthly distribution has been steady for three months so far?
Any other reason for the 3.77% “net” to average dividend versus the 3.0% distribution??
Note: The numbers follow the same pattern for RCD.
Looking back at the performance for these ETFs over the last 3 years, it looks like they have lagged the leading broad-based ETFs in all 3 categories. Another win for broad-based indexes.