As we enter year three of record low interest rates, many investors continue to face significant challenges in constructing a portfolio that delivers attractive current income without taking on considerable risks. With interest rates on investment grade fixed income securities pushed down, investors who require a constant stream of payments from their portfolios have been forced to get creative in their search for yield. Some have found attractive options in emerging market debt or junk bonds, while others have looked beyond fixed income to address a “yield deficiency.” Enter dividends, a powerful tool that and investing strategy that may be attractive to various types of investors [Download 101 ETF Lessons Every Financial Advisor Should Learn].
At first glance, it can be easy to overlook dividend yields when making investment decisions. For example, seeing a 2% yield on a fund may seem minuscule, but consider this; a portfolio with a baseline investment of $100,000, earning an average 2% annually off of dividends will appreciate to approximately $122,000 in 10 years, and nearly $150,000 in 20 years, assuming the gains are re-invested and no appreciation in stock price. In fact, a recent study conducted by Standard & Poor’s revealed that dividend components were responsible for 44% of the total return in the last 80 years of the S&P 500′s history. From 1950 until 2010, an investment of one dollar with dividends and reinvestment would have performed eight times better than a dollar invested in a non-dividend fund; that dividend invested dollar would be worth roughly $500 today [see also Examining International Dividend ETFs].
Dividends can also be used as a partial hedge in bear markets. For instance, the last 10 year have been coined “The Lost Decade” for the U.S. stocks, as equities finished lower at the end of 2009 than they began in 2000. The S&P 500 returned -2.7% in the 2000′s, the worst decade in over 50 years. But, the average dividend distribution for the 2000′s was 1.8%, cutting losses from -2.7% to just -0.9%. And in decades where average stock prices rose (which is every decade from 1950 until 2000), gains are only furthered by strong dividends. Simply put, dividends provide stability even when markets stumble [see also How To Find The Right Dividend ETF].
Another popular use for dividends is to hedge against inflation. Given policies implemented in recent years, many believe than an uptick in inflation is inevitable. Many investors concerned about the impact of inflation turn to “inflation-protected” bonds as the default option, but there are some very serious potential drawbacks to these strategies [see TIP: Silver Bullet Or Steel Trap?]. Dividends have a tendency to rise in inflationary environments, providing some hedge against rising prices.
Other advantages of dividend investing include a tendency to avoid stocks of fraudulent companies; it is relatively easy for companies to cook the books and manipulate earnings, but there is no substitute for cash payouts made directly to investors–dividends are hard to fake [see also Three Global Dividend ETF Options].
The ETF boom of the last several years has provided investors with options for accessing new asset classes and pursuing various investment strategies through exchange-traded products. There are dozens of funds available that offer exposure to dividend paying companies, including both explicit dividend-weighted products and others that focus on sectors that have a tendency to make hefty payouts (such as utilities). Below, we outline six dividend paying ETPs for investors looking for juicy yields in 2011 [for more ETF insights, sign up for our free ETF newsletter]:
WisdomTree Global Equity Income Fund (DEW)
WisdomTree’s product lineup is full of ETFs linked to dividend-weighted products, offering yield hungry investors a number of both broad-based and more precise options for investing in dividend-paying stocks. DEW is perhaps the broadest of all the company’s equity ETFs, seeking to replicate an index that consists of global companies offering high dividend yields. The underlying WisdomTree Global Equity Income Index offers exposure to about 200 individual components from both developed and emerging markets, and has a dividend yield of about 3.4%.
WisdomTree also offers an emerging markets dividend ETF (DEM), a large cap U.S. dividend ETF (DLN) and a couple ex-financials dividend ETFs (DTN, DOO) for investors looking to avoid the tilt towards banks that usually accompanies a dividend strategy [see DTN Realtime Rating].
JPMorgan Alerian MLP Index ETN (AMJ)
This ETN is linked to a market-cap weighted, float-adjusted index created to provide a comprehensive benchmark for investors to track the performance of the energy MLP sector. The majority of MLPs currently operate in the energy infrastructure industry, owning assets such as pipelines that transport crude oil, natural gas, and other refined petroleum products. The fund’s top three holdings consist of Enterprise Products (13.5%), Kinder Morgan Energy (12%), and Plains All American Pipeline (6%). For those unfamiliar with MLPs, they are Master Limited Partnerships primarily involved in the transportation of fossil fuels. They typically generate fee-base revenues which tend not to be directly tied to changes in commodity prices and thus are often less volatile plays on oil and natural gas [see also MLP Exposure: ETF or ETN?].
In order to maintain eligibility for certain tax advantages, most MLPs pay out a big chunk of their earnings in regular quarterly dividends, making this corner of the domestic energy market an appealing option for investors looking for stable but material current returns. The index underlying AMJ currently offers a dividend yield of around 5%. MLPs have become increasingly popular sources of yield in recent years, and there are now six different options in the MLP ETFdb Category.
Guggenheim Canadian Energy Income ETF (ENY)
ENY seeks to replicate the Sustainable Canadian Energy Income Index, which is comprised of approximately 30 stocks selected, based on investment and other criteria, from a universe of companies listed on the Toronto Stock Exchange, NYSE AMEX, NASDAQ or NYSE. Canada is one of the leading nations on the globe when it comes to energy output, especially for developed markets. The country has the second largest oil reserves behind Saudi Arabia, making it a global energy superpower. ENY’s top holdings include Canadian Oil Sands Trust (7%), and Suncor Energy (6.5%).
This ETF has had an impressive performance in the past year, gaining over 23%, but it is the dividend yield that investors should pay special attention to. Because many major oil companies typically pay out healthy dividends, ENY is able to boast a current 30 day SEC yield of 3.57%. Similar to AMJ, this fund will exploit the fact the global demand for oil is constantly on the rise, so along with a strong dividend, this fund also has hefty growth potential as well [see also Energy ETFs: Six Very Different Ways To Play].
iShares Dow Jones EPAC Select Dividend (IDV)
This ETF tracks an index which measures the performance of a selected group of companies that have provided relatively high dividend yields on a consistent basis over time. Right off the bat, the first thing investors should note about this fund is that it has no U.S. exposure. Instead, IDV focuses on Australia (21%), the U.K. (20%), Italy (10%), and France (6%). This may be an attractive aspect for investors who have lost faith in domestic markets and the bleak returns they have offered the past ten years. IDV features prolific global names such as British American Tobacco (3.5%) and Royal Dutch Shell (3.5%) in its top holdings. The fund holds over 100 securities, giving it a healthy diversity among both sectors and firms [see also Seven ETFs For Investors Mourning The Death Of BP’s Dividend].
As far as performance is concerned, IDV had a solid 2010, returning about 10%. The ETF is currently paying out a yield of 4.47% annually, adding a robust yield to an already strong performance. This fund may be a good option for investors who believe that foreign markets are safer than the opportunities presented within the borders of the U.S., as it holds a well-diversified international exposure along with an impressive yield.
iShares S&P Global Telecommunications Index Fund (IXP)
IXP offers exposure to the global telecommunications market, including diversified communications carriers and wireless communications companies. The top holdings features the who’s who of global Telecom firms, including AT&T (15.4%), Vodafone (12.1%), Verizon (8.9%), China Mobile (4.6%), and Deutsche Telekom (3.5%). This fund presents an interesting play as the smartphone market heats up. Many argue that smartphones present one of the few major growth sectors left in the U.S., and with the rapid expansion of technology, this ETF may present a strong growth opportunity as well.
Telecom providers have long been known for their strong dividend payouts, as AT&T and Verizon are among the top dividend payers in U.S. equities. Because of this, IXP is able to boast a current dividend yield of about 4%. From a performance perspective, this fund has returned approximately 12.4% in the past year [see also Apple & Verizon Team Up On iPhone: How Will ETFs Respond?].
PowerShares High Dividend Yield Financial Portfolio (KBWD)
As the name suggests, this fund offers exposure to financial firms that feature attractive dividend yields. Unlike many ETFs in the Financials ETFdb Category, KBWD is light on exposure to big Wall Street banks; instead it focuses primarily on small and mid cap stocks. American Capital Agency and Chimera Investment Corp. are among the largest individual holdings.
KBWD was recently offering investors a distribution yield in the neighborhood of 9.4%, considerably higher than the expected payout from even most junk bond ETFs. For investors willing to take on the risk that comes with an investment in high yielding financial firms, KBWD offers current return potential that few ETFs in any asset class will be able to match.
Disclosure: Photo courtesy of Luca Galuzz. Jared is long VZ.