A tale of 3 dividend funds

The coronavirus pandemic has upended many things for investors, including long held assumptions about what constitutes safety and security when it comes to dividends.

Six months ago, who would have thought that Montreal’s CAE Inc. or mighty Walt Disney Co. would suspend their dividends? Or that for the first time in 30 years a Canadian bank, the seventh largest Laurentian, would cut its payment by 40% to conserve cash.

Dividends are a portfolio anchor. Companies that can afford to pay them tend to be stable with strong, established businesses. Dividend power is a proven supercharger to returns, over the long term providing between 30% and 40% of gains. But just as the market recovery has been uneven since the mid-March selloff, so has the performance of funds that specialize in dividend stocks.

The differences reveal the benefits of diversification and the perils of a home country bias. They also show how passive funds, which follow indexes, may not be as nimble as actively-managed funds, which rely on the judgment of managers to adjust holdings.

A home country bias has come home to roost in the recent performance of Canadian-only dividend funds. They tend to be weighted towards banks, utilities, real estate, and energy. These sectors have a history of solid performance with steady dividend growth and high yields. But three of the four have been hard hit by the pandemic.

Banks face higher loan losses, their margins are being squeezed, and some customers are deferring mortgage and loan payments. As the work-from-home movement grows, real estate investment trusts (REITs) are wondering how much rent they can collect and from whom. Energy companies face the twin challenges of slumping demand and rising anti-oil sentiment.

If these sectors are major components of your dividend fund, then it hasn’t been doing well.

The ETFs below hold high-quality stocks and are marketed as safe ways to generate income.  Each has its own distinctive approach. One is actively managed, while the other two follow indexes. They offer different degrees of geographic and sector diversification. As a result, their performance varies considerably.

Horizons Active Global Dividend ETF (TSX: HAZ) 

Background: This actively managed ETF is the top performer this year. Its holdings are in North America and Europe and it aims to provide steady dividend income and modest capital growth by investing in some of the world’s best dividend paying stocks. It is sub-advised by Guardian Capital Corp. with selections based on three main criteria: dividend growth, payout ratio, and sustainability of the payout.

Performance:   It closed closed Friday June 26 at $22.73 and according to Morningstar Research, the ETF has a total return of 0.39% year-to-date (as of June 24) versus a decline in the S&P/TSX index of 8.78%. Its one and three-year total returns are 4.20% and 6.09% respectively. The current annual dividend yield is 2.19%.

Morningstar ranks the fund as 31st out of 1,638 similar funds year-to-date.

Holdings: The ETF holds 39 companies. The top three are:  Mastercard, Apple, and Microsoft. The geographic breakdown is U.S. (69%), Switzerland (9%), and Canada (7%).

The top three sectors are technology (22%), healthcare (15%), and consumer staples (15%).

Key metrics: The fund was launched in 2010, has $179.5 million in assets under management, and comes with a management fee of 0.65%, the highest of the group.

Discussion: The ETF is the only one of the three to be in positive territory this year. The edge comes from the ETF’s weighting in technology, healthcare, and consumer defensive stocks. All three sectors have outperformed. Another edge is diversification beyond Canada and the U.S.

While many companies in the ETF may hold off on dividend increases, few are likely to cut them.

 iShares Core Dividend Growth ETF (NYSE: DGRO)

Background: This broadly diversified, passively managed ETF follows 477 U.S. stocks with a history of dividend growth. It tracks the Morningstar US Dividend Growth Index. It is the second-best performer this year.

Performance: This ETF closed Friday at U.S.$36.57.  Year-to-date, the ETF is down 8.45% (as of June 24.) The one and three-year average annual total returns are 1.67% and 9.15% respectively. The ETF has a trailing 12-month dividend yield of 2.54% and is ranked 9th of 1,223 similar funds by Morningstar.

Holdings: The top three sectors are information technology (19.5%), financials (19%), and healthcare (19%), so the fund lacks the consumer defensive component in the Horizons ETF top three.  The major holdings are Microsoft, Apple, and Chevron, two of which overlap with Horizon.

Key metrics: The ETF was launched in 2014 and has U.S. $10.5 billion in assets. The management fee is a low 0.08%.

Discussion: The ETF is down more than the 7.7% decline for the S&P 500 index (as of June 24). One reason is that dividend growth is a main criterion and many companies in the ETF are delaying or postponing increases.

While technology and healthcare stocks are beating the market, the banking sector is weighed down by the twin headwinds of narrowing spreads and rising defaults.

Even so, the yield is good, and the assets of the underlying companies are strong.

iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (TSX: CDZ)  

Background: This passively managed ETF has 82 holdings and has performed worst. It replicates the S&P/TSX Canadian Dividend Aristocrats Index which is composed of high-quality Canadian companies that at a minimum have increased their dividends in each of the least five years.

Performance: The fund closed at $21.93 Friday and is down 18.6% year-to-date (to June 24.) It lost 11.8% in the past 12 months and is down an average of 0.29% a year on a three-year total return basis. The current dividend yield is a high 5.24%.

Holdings: The top sectors are financials (25%), utilities (16%), and real estate (13%). The top three holdings are Transalta Renewables, Fiera Capital, and Transcontinental.

Key metrics: The fund was launched in 2006, has $742 million in assets and a management fee of 0.6%.

Discussion:  The ETF’s performance shows the hidden risks of a home country bias.  Banks, real estate, and energy stocks make up almost half of the fund’s holdings and are all in for a rough ride.

The S&P/TSX Capped Energy Index is down 47% this year and the S&P/TSX Capped Financial Services Index is down 17%.  Canadian banks, which could be counted on to raise dividends once and sometimes twice a year, are freezing or cutting payments. The Laurentian Bank dividend cut was a confidence shaking move.

Real Estate Investment Trusts (REITs) are actively reducing and in some cases suspending distributions, particularly in the office and retail space. The sector is among the worst TSX performers. The S&P/TSX Capped REIT Index is down 22%, almost 2-1/2 times the  9 per cent decline of the S&P/TSX Composite Index.

The fund is ranked 92nd of 486 funds in its group.

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 (This article appeared in the June 29, 2020 issues of the Internet Wealth  Builder investment newsletter.)