Exchange-traded fund provider Source has launched three smart beta income ETFs to help address the challenge of finding attractive dividend paying stocks.

The funds, launched on the provider’s new physical ETF platform, track the FTSE RAFI Equity Income Indices which target either US, UK, or European exposures. The ETFs utilise a proprietary methodology from Research Affiliates, a leader in smart beta and asset allocation, to invest in high-dividend-paying stocks that have been screened to favour sustainable income.

Rob Arnott, Chairman and CEO of Research Affiliates.

To construct the indices, Research Affiliates uses fundamental measures to screen out those companies in poor financial health, and then from the remaining stocks selects 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.

Rob Arnott, Chairman and CEO of Research Affiliates, commented: “We’re excited about our new Equity Income Index Series, and we are pleased to partner with Source to deliver these innovative solutions to investors. Although there are a number of dividend-based indexing strategies on the market, few seek to assure that the stock is attractively priced on measures other than the dividend yield, and even fewer filter to assure that the dividend is sustainable.  We believe our extensive research in the smart beta area has allowed us to produce a truly superior way to earn solid and sustainable income from an equity portfolio.”

The launch of the new ETFs coincide with the release of research, conducted by Source during February. The report surveyed 77 institutional investors concerning their expectations surrounding global dividend levels. It found that 72% of institutional investors believe dividend growth will be 5% or less this year, compared to growth of 9.3% globally in 2015. This may explain why over the next two years, almost half (48%) of institutional investors believe that investing for income will become more important.

Additionally, 59% say the chances of investors being caught out by a ‘value trap’ – picking a stock that pays an attractive dividend but the dividend then falls sharply, or one that should pay a dividend but never does – will increase. Source argues the research is indicative of a growing need for innovative approaches to income investing that addresses issues such as the quality and sustainability of dividends.

Dr. Chris Mellor, Executive Director, Equity Product Management at Source, added: “Many investors have been struggling to generate income in the current environment, with bond yields low and with most high-yielding equity strategies being overly exposed to low quality or low growth stocks. Our investors said they wanted a strategy that focuses on dividends and doesn’t give you exposure to low quality companies. This is precisely what we worked with Research Affiliates to develop, which has culminated in the new FTSE RAFI Equity Income Indices.”

The Source FTSE RAFI Europe Equity Income Physical UCITS ETF (DVEU) trades in euros on the Xetra Exchange; the Source FTSE RAFI UK Equity Income Physical UCITS ETF (DVUK) trades in British pounds on the London Stock Exchange; and the Source FTSE RAFI US Equity Income Physical UCITS ETF (DVUS) trades in US dollars on the London Stock Exchange. Each fund has a total expense ratio of 0.35%.