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May-18-11

Canadian Dividend ETF Comparison – The Importance of Due Diligence

One of our suggested readings in a prior week was a piece by Tom Bradley, President of Steadyhand Investment Funds, which discussed the 145 ETFs that are now available in the marketplace. As he says: “ETF-land is now a busy and complicated landscape”.

On April 18th, 2011, iShares released one of its latest ETFs to the Canadian marketplace, to the delight of income starved investors. The iShares S&P/TSX Equity Income (XEI), with a net dividend yield of 5.21%, now brings the number of passively managed Canadian dividend index ETFs to 3 (the other 2 are the iShares Dow Jones Canada Select Dividend ETF (XDV) and the Claymore S&P/TSX Canadian Dividend ETF (CDZ)). Each of these ETFs has significant differences that must be considered before including them in any portfolio (for a quick reference sheet, please see attached comparison)

Equity Sector Concentration Risk

XDV’s financial sector allocation is a massive 53% (there are no restrictions on sector weights). All sectors are capped at 30% for XEI, partially solving the overconcentration issue inherent in XDV. CDZ appears to be the most diversified across sectors in comparison, even without any sector capping criteria.

“Big 6” Bank Exposure

Most Canadian investors already have plenty of exposure in their portfolios to the Big 6 banks. CDZ could complement a bank heavy Canadian equity allocation due to its 0% allocation to the Big 6 banks. In comparison, XDV has 31% exposure and XEI has 17%.

Equity Size Risk

CDZ has an alarmingly high allocation invested in small cap stocks, which are normally less liquid (larger spreads) and more volatile than large cap stocks: overall, its allocation is 35%. XDV is also on the high side at 21%, with XEI coming in at a more reasonable 9%.

Dividend Yield (net of estimated MER)

XEI takes the prize in this category, with a net dividend yield of 5.21% - however, one has to question how sustainable the high dividend payouts are for a number of these companies. XDV and CDZ come in at a much lower 3.46% and 2.77% net dividend yield respectively, but the underlying companies have a proven track record of consistent and increasing dividends.

Dividend Criteria for Index Inclusion

XEI – company must have a non-zero dividend yield (lowest quality dividend requirement)
XDV – company must have paid dividends in each of the 5 previous years, as well as have a non-negative historical 5-year dividend-per-share growth rate
CDZ – company must have increased dividends every year for at least 5 consecutive years (highest quality dividend requirement) – this is the reason for the lack of Big 6 bank exposure in the ETF.

Number of Holdings

XEI will hold 50 to 75 stocks. XDV will hold 30.  Due to the strict eligibility criteria of the underlying index that CDZ follows, it cannot be determined how many securities will be included at each subsequent rebalancing event (it currently stands at 39).

Portfolio Turnover

From the index methodology available, it appears that XDV has the potential for the least amount of turnover (an investor in the highest marginal tax rate with no capital losses carrying forward should pay close attention to the portfolio turnover rate). Eligible stocks are first ranked by their dividend yield in descending order. If any stocks that are currently in the index form part of a new top 40 list of dividend payers, they all remain in the index (regardless of whether or not a “new-comer” has a higher rank than them). Only if any of the former 30 companies are no longer in the top 40 list, will any new additions and deletions be made (starting with the top-ranked dividend payers). In all likelihood, the names in the index could look very similar across multiple rebalancing events. CDZ has the potential to drop names and not include them again until the company proves that they can create another 5-year history of consistent dividend increases. XEI has quarterly rebalancing frequencies, which could cause stocks to be sold in one quarter, and subsequently repurchased in another, especially during periods of volatile markets.

Conclusion

Clearly, these ETFs are not equal. It is important to dig into the fund data to thoroughly understand the underlying characteristics and how they relate to your overall portfolio. With 145 ETFs in the marketplace, and the number constantly increasing, it is even more important than ever to complete these due diligence exercises.

By: Justin Bender | 1 comments
May-02-11

How to Calculate your Portfolio’s Rate of Return

Many of our PWL Toronto clients have asked me to help them better understand how their portfolio’s rate of return is calculated (PWL currently uses the “Modified Dietz Method” to calculate portfolio returns). The attached paper, “How to Calculate your Portfolio’s Rate of Return”, highlights a number of popular return calculation methodologies, while discussing some of the pitfalls investors should be aware of while attempting to calculate an approximate rate of return for their own portfolio.

To view PDF click here.

By: Justin Bender | 0 comments