The Tangerine Investment Funds have long been part of my model portfolios, as they’re a simple way to build a broadly diversified index portfolio with a single product. With a management expense ratio (MER) of 1.07% they are not the cheapest option, but they offer a lot of convenience for investors who aren’t ready to manage a portfolio of individual index funds or ETFs.
This month the Tangerine family grew for the first time in five years with the launch of the Tangerine Dividend Portfolio.
As with the existing members of the Tangerine lineup, the Dividend Portfolio includes a mix of Canadian, US and international equities. But whereas the older funds track traditional indexes of large and mid-cap stocks, the new one is focused on yield. It tracks three MSCI indexes that screen for companies with dividend payouts at least 30% higher than average, as well as “quality characteristics” that suggest these yields will be sustainable.
- The MSCI Canada High Dividend Yield Index currently holds 22 stocks, including the usual suspects such as Fortis, TransCanada, Telus, and the big banks. About 44% of the index is made up of financials, while another 23% or so is energy stocks.
- The MSCI USA High Dividend Yield Index, not surprisingly, is much larger and more broadly diversified. It includes 128 companies, including blue-chip stalwarts like Microsoft, Johnson & Johnson, Exxon Mobil, and Coca-Cola. The largest sectors are information technology and consumer staples, each at about 21%.
- The MSCI EAFE High Dividend Yield Index includes 120 companies in developed countries in Europe and Asia, as well as Australia. The UK, Germany, and France together make up almost two-thirds of the index. Financials are 23%, with other large slices are in health care, materials, and consumer staples.
Unlike the three balanced Tangerine portfolios—which allocate equal amounts to Canadian, US and international equities—the new dividend fund has a 50% target for Canadian stocks, with 25% each allocated to the US and overseas. That’s probably not rampant home bias: rather, it’s likely because dividend-oriented investors often focus on domestic stocks for their favourable tax treatment.
Consider an Ontario investor who earns $40,000 in employment or pension income, plus an additional $1,000 in dividends. If those dividends are from eligible Canadian companies, they would carry a negative tax rate, reducing the investor’s tax bill by almost $70. An additional $1,000 in foreign dividends, by contrast, would add another $200 or so to her tax bill.
At higher income levels the benefits of the dividend tax credit are more modest, but still significant: even with $100,000 of income, eligible Canadian dividends are taxed at 25.38% in Ontario, compared with 43.41% for foreign dividends and interest. (Ontario is roughly average among provinces.) So it’s no wonder a dividend fund would allocate half its assets to Canadian stocks.
The downside of high yields
Despite these tax benefits, however, I wouldn’t recommend the Tangerine Dividend Portfolio as a core holding for a couple of reasons.
The first is the lack of diversification. The 50% allocation to Canadian equities is already high, and it’s made worse by the fact that the index holds just 22 companies. Even a traditional Canadian equity index fund has some diversification problems with 240-plus companies and 34% in financials. The focus on dividends just makes this concentration risk that much higher.
Let’s also remember that the tax-efficiency of Canadian dividends will be irrelevant for many investors in this fund, since it applies to non-registered accounts only. I don’t have any data to back this up, but I’m guessing that many (if not most) people using the Tangerine portfolios are investing in RRSPs or TFSAs, where the dividend tax credit is a non-issue.
Moreover, while Canadian dividends are favourably treated in non-registered accounts, a high-dividend strategy for foreign stocks isn’t tax-efficient at all. Dividends from US and international companies are taxed at your full marginal rate, just like interest. Meanwhile, capital gains from those same stocks can be deferred until you eventually sell them, at which point they are taxed at only half your marginal rate. So before taxes, a 5% capital gain plus a 2% dividend—what you might expect from a broad-market US equity index fund—is equivalent to a 3% capital gain plus a 4% dividend. But the former would lead to a higher after-tax return.
Finally, focusing on dividends for US and international equity holdings is likely to be less tax-efficient even in a TFSA or RRSP. When you hold mutual funds in these accounts, dividends from foreign companies are subject to withholding taxes: 15% on US dividends and a somewhat lower percentage for overseas dividends (the rate depends on the country). So, again, assuming a broad-market fund and a dividend-focused fund deliver similar pre-tax returns, even a TFSA or RRSP investor would earn a higher return from the one with the lower yield.
And now the good news
The launch of the new Tangerine Dividend Portfolio prompted a change in one of the other funds in the family. The Tangerine Equity Growth Portfolio, launched in 2011, had previously been the only member of the lineup to exclude bonds. It tracked the same equity indexes as its sister funds: the S&P/TSX 60 for Canadian stocks, the S&P 500 for the US, and the MSCI EAFE for international. However, the Equity Growth Portfolio allocated 50% to Canada.
But not anymore. Since the arrival of the new dividend fund, the Equity Growth Portfolio has changed its mandate and now holds equal amounts of Canadian, US and overseas stocks, just like the three balanced funds in the Tangerine lineup.
In my view, this makes the fund more attractive for investors seeking a global all-stock index fund. If you’re not ready to go 100% equities and you’d like to hold your investments at Tangerine, you could even combine the Equity Growth Portfolio with some cash and GICs and build your own balanced portfolio. That would lower your overall volatility and bring down your costs as well.