Historically, dividends have been a major source of the stock market’s overall total returns, and the reinvesting of those dividends has boosted returns even further since compounding is quickened.
But not just any high yielding stock will do. It takes the right blend of factors to make a “quality” dividend. The new O’Shares FTSE Quality Dividend ETF (OEUR ) hopes to bring those qualities to your international portfolio.
Inside OEUR's Strategy
While most people know Kevin O’Leary from the hit ABC show Shark Tank, he’s also one of the principals and founders of O’Leary Funds Management LP. Originally designed to manage his family’s wealth, O’Leary Funds has grown to $900 million in investor assets (as of 9/3/2015). These include the new O’Shares line of ETFs. Focusing on the firm’s core ideals of income, wealth preservation, and capital appreciation, O’Leary and his crew have crafted a series of smart-beta ETFs designed to focus on “quality” dividends. The idea is that various metrics can be used to determine if a dividend is the real thing or just smoke-and-mirrors prone to blow up/be cut.
OEUR tracks the FTSE Europe Quality/Volatility/Yield Factor 5% Capped Index, which is a measure of European large- and mid-cap dividend-paying issuers that meet certain requirements for market capitalization, liquidity, high quality, low volatility and dividend yield. By screening for high-quality factors such as cash flows, debt, earnings growth, and low volatility, OEUR hopes to reduce its exposure to dividend-paying stocks that meet the definition of “troubled”. Usually, stocks with very high yields are often troubled and a really high yield is generally unsustainable.
OEUR's Portfolio
As of September 2015, the ETF holds 144 different European dividend payers. In terms of sectors, both health care and consumer goods (staples and discretionary) come in at 19.3% of assets each. That’s understandable as Europe is home to some of the world’s largest drug and food manufacturers. The oil and gas sector comes in next at 11.4%, while telecoms and financials round out the top five.
And while OEUR claims to have a broad European mandate, the vast bulk of its assets are in a few select nations; only eight, in fact, with the top nation the United Kingdom. Stocks from the U.K. make up nearly half of the fund. Switzerland and France are the only other two nations with double-digit exposure. However, OEUR does provide exposure to Germany, Sweden and the Netherlands. Additionally, even with such a small portfolio of nations, OEUR provides exposure to several of Europe’s various currencies; the franc, pound, euro and krona are all represented.
Considerations for OEUR
Given OEUR’s smart-beta nature and pan-European exposure, investors must take some key points into consideration before investing in the ETF.
To start with is the fund’s currency risk. Since the end of the global credit crisis, the U.S. dollar has been on a tear and has continued to inch higher. Much of that has come at a cost to the various European currencies. That’s a problem when it comes to returns as translating the fund’s greenbacks into euros, kronas, or whatever, can actually zap returns. Currency movements are sometimes enough to turn potential gains, in local terms, into losses when translating them back into dollars. The same can be said for those promised juicy dividends. A stock like Novartis (NVS), OEUR’s largest holding, pays its dividend out in francs. If the dollar is high, investors get fewer francs for their dollar, meaning that NVS yield/payout is actually lower. The firm does offer the O’Shares FTSE Europe Quality Dividend Hedged ETF (OEUH ) which attempts to take currency out of the equation.
Secondly, there could be fierce competition in the space and OEUR could eventually close on account of low assets. There are over 65 European-focused ETFs in the space. These run the gamut from multi-billion broad-indexed ETFs, like the Vanguard Europe ETF (VGK ), to other quality dividend funds such as the WisdomTree Europe Dividend Growth ETF (EUDG ). And this doesn’t cover the billions of dollars in EAFE-indexed ETFs as well. The point is, OEUR is launching into a very crowded ETF sub-sector.
Finally, one of the biggest issues with smart-beta products is that their performance hinges on the factors that are chosen to create them. Bet on the wrong factors and your ETF is sunk. There’s no guarantee that OEUR is making the right choice when looking at its factors. In fact, some requirements, like its volatility requirement, will work against it in rising markets.
How to Use OEUR in a Portfolio
While OEUR is advertised by O’Shares as a core piece of a portfolio, investors may want to rethink that stance. The lack of exposure to some European names, and the highly defensive nature of its holdings, could make it unsuitable for that use. A better bet would be to use it alongside a broad European ETF such as the previously mentioned VGK or the iShares Europe ETF (IEV ). Investors can use it to boost the overall yield of their international portfolio and potentially reduce some of the downside risk.
The Bottom Line
The new O’Shares FTSE Quality Dividend ETF (OEUR ) brings the concept of quality dividends to the broad European equities. All in all, OEUR provides a great way for investors to add a swath of Europe’s largest and most stable firms as well as add some extra income/yield to their portfolios. Just keep in mind that the ETF isn’t currency hedged.
Disclosure: None
