European exchange-traded fund provider Source has put out research suggesting there is a growing need for innovative approaches to income investing and addresses issues such as the quality and sustainability of dividends. It suggests that this may help investors avoid a ‘value trap’ – picking stocks that pay an attractive dividend but then find the dividend falls sharply, or one that should pay a dividend but never does.
Dr. Chris Mellor, Executive Director, Equity Product Management at Source.
The research comes from Source’s survey of 77 institutional investors, which found that more than 61% of institutional investors anticipate that dividends from UK companies will stay the same or decline this year when compared to 2015. It also found that while 52% of those surveyed anticipate a negative outlook for dividends from US equities, 64% of institutional investors believe European dividends will fall or remain the same in 2016.
Oil and gas companies are expected to experience the largest fall in dividends with 77% of those surveyed anticipating the energy sector to be one of the three worst dividend performers this year. A significant proportion of institutional investors also cited the industrial goods and services sector (41%) and banking and financial services sector (41%) as being in the worst three performers. When asked which three sectors would see the biggest rise in dividends paid this year, 43% said healthcare, 35% said banking and finance and 32% said technology.
Earlier this month, Source and Research Affiliates, a global leader in smart beta and asset allocation, launched three smart beta income ETFs that provide exposure to the new FTSE RAFI Equity Income Indices. These target high-dividend-paying stocks that have also been screened to favour sustainable income. The ETFs offer investors a choice between US, UK, and European exposure.
Dr. Chris Mellor, Executive Director, Equity Product Management at Source, commented: “Finding quality stocks that pay attractively consistent dividends is becoming much more challenging. Given this, we teamed up with Research Affiliates, the market leaders in smart beta, to develop a suite of ETFs that addresses this growing issue.”
The new ETFs use Research Affiliates fundamental measures to screen out companies in poor financial health and, from the remaining stocks, select the top 50% in each sector based on their dividend yield. It then weights the constituents by the product of their dividend yield and RAFI fundamental weight, which is based on four fundamental measures of the company’s size rather than its market capitalisation. The aim of this process is to build a portfolio of high-yielding, high quality stocks while avoiding excessive sector tilts and the biases that are inherent in market-cap-weighted indices.
The newly launched smart beta income ETFs from Source include:
Source FTSE RAFI Europe Equity Income Physical UCITS ETF (DVEU)
Source FTSE RAFI UK Equity Income Physical UCITS ETF (DVUK)
Source FTSE RAFI US Equity Income Physical UCITS ETF (DVUS)
Recent research from State Street Global Advisors also shows that companies with sustainable dividends have historically provided a superior degree of downside protection when compared to broad market exposure. The paper found that the average drawdown on SPDR S&P Dividend ETF (SDY), a portfolio of stocks which have increased their dividends for a minimum of 20 consecutive years, was significantly less than the drawdowns on the S&P 500 Index during market downturns.
Other income focused ETFs that utilise quality screens to enhance the sustainability of their dividend yields include:
iShares MSCI USA Dividend IQ UCITS ETF (QDIV)
BMO MSCI USA Income Leaders Index UCITS ETF (ZILS)
BMO MSCI Europe ex-UK Income Leaders Index UCITS ETF (ZILE)
BMO MSCI UK Income Leaders Index UCITS ETF (ZILK)
BMO MSCI USA Income Leaders (GBP Hedged) UCITS ETF (ZISG)
BMO MSCI Europe ex-UK Income Leaders (GBP Hedged) UCITS ETF (ZIEG)
Lyxor SG Global Quality Income NTR UCITS ETF (SGQI)
Lyxor SG European Quality Income NTR UCITS ETF (SGQE)