You have a great business idea. Perhaps it’s something unique or something you’re particularly good at. How do you know whether you should invest in it or simply keep it as a hobby?
Adam Grant, Organizational Psychologist at Wharton, created the following graphic to help answer that question.
How to decide whether your idea should become a project: 1. Interest: do you think about it in your free time and bring it up in random conversations? 2. Importance: will it benefit others? 3. Contribution: do you have something novel to add?
James Altucher – serial entrepreneur, author, podcast host – expands on this:
A) always good to have a couple of things going on at a time to see if they fall within the sweet spot of the diagram since so very few things do.
B) learn the skill of “experimenting” so you can take small steps with little downside and great upside to see what things “click”.
C) often something feels like it hits the sweet spot but then it stalls. Don’t be afraid to quit something that’s not quite clicking.
D) I always wait for my heart and mind to agree before I fully engage in a new activity.
Too often I did things for money that I did not love and too often I did things for my heart that had no other benefit to me.
The heart and the brain must be in agreement. Experiments helped me with that.
Example, I’ve spent the past 5 years doing standup comedy up to 20-30 hours a week. It’s not monetizable. But it added to my skills in podcasting, public speaking, ideation, etc.
But, mindlessly playing online chess for hours a day (which I am prone to do) is my heart talking but not my brain.
And starting a hedge fund way back when was my brain talking but not my heart. I hated every minute of it and not a good source of income ultimately.
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The Covid-19 economic crisis is gripping the world. After 20 years in the asset management business, it looks like we are fighting through unprecedented territory.
This is war. I created a 17 step, 47 page guide to help DumbWealth subscribers get through this.
I originally planned on printing the guide and selling copies for $20+. Instead I’m giving this away free because I think we all need to help each other during these difficult times.
The number one gimmick investment fund marketers use to sell their products is a strong performance track record. Historical performance is considered a staple piece of information by fund marketers and unitholders, as it makes the product appear more tangible.
Unfortunately, historical performance is useless when evaluating a fund.
You’ve probably seen the following disclaimer along in most investment funds marketing:
“Historical performance are not indicative of expected future returns and may not be repeated.”
This disclaimer is there for a reason. It is added to marketing materials because the regulators know that funds are sold based on historical returns, so they want it to be clear that past performance has nothing to do with future performance.
Even if all aspects of the fund – the manager, the style, the investment policy guidelines – remain the same, the vast majority of strong performance is fleeting in nature and cannot be repeated. Managers can get lucky streaks that result in periods of outperformance. However, few have genuine skill and are unable to repeat this outperformance consistently.
The empirical evidence supports this.
In its report called “Persistence Scorecard”, Standard and Poors regularly provides data on the persistence of investment manager outperformance. On July 15, 2020, for the first time, S&P has calculated this for the Canadian market.
The Persistence Scorecard attempts to distinguish luck from skill by measuring the consistency of active managers’ success. The inaugural Canada Persistence Scorecard shows that, regardless of asset class or style focus, few Canadian fund managers have consistently outperformed their peers.
For example, across all seven categories we track, none of the equity funds in their category’s top quartile in 2015 maintained that status annually through 2019. If we consider funds in the top half of 2015’s performance distribution, in six of the seven categories fewer than 5% of funds maintained their performance over the next four years. Coin flippers had higher odds of success.
In general, very few Canadian investment managers have demonstrated that periods of outperformance were due to skill and could be repeated.
Lengthening the horizon to consider performance over two consecutive five-year periods, the top-quartile domestic equity funds of 2010-2014 had little luck maintaining their top-quartile status during the 2015-2019 period. Only 30% of them managed to beat the median while 23% ended up in liquidation or had a style change.
While there may be a handful of investment managers that possess the skill to consistently outperform the market, it is impossible to identify these people in advance. The evidence shows that the vast majority of investment managers cannot repeat periods of outperformance. Yet these active investment managers charge 2.5% for the pleasure of their underperformance.
Consequently, investors would do much better by using low cost index funds and instead focusing on managing their investing behaviour, savings rate, debt, taxes and asset allocation.
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The Covid-19 economic crisis is gripping the world. After 20 years in the asset management business, it looks like we are fighting through unprecedented territory.
This is war. I created a 17 step, 47 page guide to help DumbWealth subscribers get through this.
I originally planned on printing the guide and selling copies for $20+. Instead I’m giving this away free because I think we all need to help each other during these difficult times.
A reader recently asked me about the TSX-listed iShares S&P/TSX Composite High Dividend ETF (XEI). XEI invests in a range of dividend paying Canadian companies and features a 6.26% distribution yield (June 30, 2020). The ETF pays roughly $0.075 to $0.091 per share on a monthly basis providing an attractive income stream. XEI’s management fee is 20bps.
Is XEI too good to be true? Or is it a great income provider?
Currently, XEI remains about 26% below its February 20, 2020 peak before the Covid-19 market crash. In comparison, the S&P/TSX Composite Index only remains about 13% below it’s February 20th level. This divergence can mainly be explained by differences in the holdings. The S&P/TSX Composite Index, for example, holds gold miners and Shopify which have been performing very well since the March 23rd bottom. In contrast, XEI is heavy into financials and energy, both of which have lagged. As a dividend fund this makes sense.
XEI seeks to replicate the S&P/TSX Composite High Dividend Index. For this reason, the growth and momentum names that don’t pay dividends are excluded from the portfolio.
Effective June 13 2017, the fund’s name was changed from iShares Core S&P/TSX Composite High Dividend Index ETF to iShares S&P/TSX Composite High Dividend Index ETF.
XEI Construction
To understand how XEI operates, one must look at the methodology of the underlying index. The S&P/TSX Composite High Dividend Index consists of 50 to 75 stocks selected from the S&P/TSX Composite focusing on dividend income. The index is market-capitalization weighted, with stocks capped at 5% and each sector capped at 30%. The index rebalances quarterly.
To be included in the index, a stock must be a member of the S&P/TSX Composite and have a non-zero indicated annual dividend yield. Selection is done step by step, as follows:
As of the reference date for the Composite rebalancing, S&P Dow Jones Indices determines the median indicated annual dividend yield of all stocks in the S&P/TSX Composite with non-zero indicated annual dividend yields.
The 75 stocks with the largest indicated annual dividend yield, from those stocks which have indicated annual dividend yields above the median calculated in step 1, are selected to form the index. Current index constituents are not removed unless their indicated annual dividend yield falls below the 85th position. Stocks that are not current index constituents with an indicated annual dividend yield ranking above the 65th position are automatically added to the index.
If step 2 yields fewer than 75 stocks but more than 50, stocks with indicated annual dividend yields greater than or equal to the median form the index. The buffer thresholds given in step 2 continue to be 10 ranking positions above and below the number of constituents.
If there are fewer than 50 stocks with indicated annual dividend yields above the median, stocks are added in descending order of indicated annual dividend yield below the median until a total of 50 stocks are included.
The index is market-capitalization weighted subject to a maximum weight of 5% for each stock and 30% for each GICS Sector. The caps are established at the quarterly rebalancing and are not revised until the next quarterly rebalancing.
Based on this methodology, the portfolio will provide exposure to the highest-yielding dividend stocks in the S&P/TSX Composite Index, regardless of quality. Unlike some other dividend ETFs, XEI doesn’t factor in dividend growth or longevity.
Performance
Since its April 2011 inception, on an annualized basis XEI has returned 3.09% (ending June 30, 2020). If you held until January 31, 2020 (thus avoiding the Covid-19 mess), you would have received an annualized 6.27%.
Looking back 5 years (ending June 30, 2020), XEI returned 1.23% annualized vs. S&P/TSX Capped Composite Index’s 4.45%.
For the 5 years ending January 31, 2020, XEI returned 5.62% annualized vs. S&P/TSX Capped Composite Index’s 6.53%.
While fees can explain some of the difference vs the broad benchmark, it is clear that the lack of growth names has caused total returns to lag somewhat – especially recently.
Why is the distribution yield so high?
XEI sports a 6.26% distribution yield. While total returns matter, many investors are attracted to this yield. The yield is based on the underlying components of the ETF, 49.08% of which is concentrated in the top 10 holdings.
The top 10 stocks held by XEI have dividend yields ranging between 4.74% and 8% (as of June 26, 2020). These ten holdings contribute to about half of XEI’s overall distribution.
Many funds top up their distributions by returning capital to investors. In contrast, XEI is mostly distributing dividends the fund receives from underlying holdings. In 2019 about 8% of the distribution was considered return of capital, whereas in 2018 and 2017 there was none. Most of XEI’s distribution is organic as opposed to manufactured.
Exposure
While XEI imposes a 30% cap on sector weights the fund is still quite concentrated. I would expect this, given the nature of how the ETF is constructed (essentially a sort and rank of dividend paying stocks). Naturally, XEI will have higher exposure to areas of the market that have higher dividend yields – financials, energy, utilities. 73% of the ETF is concentrated in these three sectors.
Bonus concern
It is interesting to note XEI’s high portfolio turnover. Clearly this has to do with the construction and rebalancing methodology.
Compare XEI’s 2018 turnover of 49.86% to that of the FTSE Canadian High Dividend Yield Index ETF (VDY), which is just 22.90%. This may be a nothingburger, but higher turnover strategies tend to be indicative of higher costs. However, with XEI’s management fee of just 20bps this doesn’t appear to be much of a concern.
My verdict
XEI will never hold high-flyers like Shopify or junior gold miners. So investors need to recognize that it might underperform the broad market during periods in which momentum or growth are favoured.
Given the construction methodology, it is expected that many names within XEI might have historically been poor performers. (Dividend yields rise as stock prices fall.) There is no discretion applied to what names are in XEI, so there inevitably will be a mix that could includes dogs at risk of dividend cuts. Luckily exposure to any single company is limited to 5% at the time of rebalancing.
There may also be companies with well-supported dividends that have simply underperformed (driving up the yield) for other reasons.
Conclusion: don’t buy XEI for the yield. Buy it because you like most of the companies it holds. If you think most of the underlying holdings will continue to pay their dividends and are good long-term holdings, then XEI is a convenient way to invest in those companies.
Investing in Canadian dividend paying stocks has never been easier. To do this you can either buy one or two dozen individual stocks or you can buy an ETF that already owns a basket of dividend paying companies.
Of course, the convenience of buying an ETF comes with a small price. Between 10 and 60bps, the management expenses paid for simplified access do compound over time. Still, for many the ETF option makes the most sense.
Many people don’t have time to track many individual stocks. Some investors might have little to invest. Others might not even know what to look for when choosing an individual stock. For these people, an ETF might be the best way to invest in dividend stocks.
Personally, I like the way a broadly diversified dividend ETF can help me mitigate the risk of problems with any one individual company. An ETF also allows me to make asset allocation changes and new contributions with relatively few trades. Also, those who work in the investments industry know that ETFs remain off the compliance radar providing easier buy/sell execution.
I still bolt on a few individual dividend stocks here and there to enhance certain exposures. But ETFs remains the core to my dividend portfolio.
Below I list out five of the top dividend ETFs in Canada. I first provide high-level summary stats and then go deeper into each individual portfolio. Finally, I provide my conclusions at the end.
Summary Stats
Name
BMO Canadian Dividend ETF
iShares S&P/TSX Canadian Dividend Aristocrats Index ETF
iShares Canadian Select Dividend Index ETF
Vanguard FTSE Canadian High Dividend Yield Index ETF
iShares Core MSCI Canadian Quality Dividend Index ETF
Ticker
ZDV
CDZ
XDV
VDY
XDIV
Expense Ratio
0.35%
0.60%
0.50%
0.20%
0.10%
Yield
5.57%
5.24%
5.71%
5.17%
5.26%
% Financials
33.88%
25.26%
59.85%
58.30%
56.42%
% Energy
15.25%
9.64%
6.30%
30.00%
17.72%
% Top 10
30.00%
19.95%
58.37%
73.68%
77.75%
BMO Canadian Dividend ETF (ZDV)
This ETF seeks to replicate the performance, net of expenses, of the Dow Jones Canada Select Dividend Index. The index is comprised of 30 of the highest yielding, dividend-paying companies in the Dow Jones Canada Total Market Index, as selected by Dow Jones using a rules-based methodology including an analysis of dividend growth, yield and average payout ratio.
Top 10 Holdings (30.00%)
iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ)
This ETF seeks to replicate the performance, net of expenses, of the S&P/TSX Canadian Dividend Aristocrats index. The index consists of common stocks or income trusts listed on the Toronto Stock Exchange which are constituents of the S&P Canada Broad Market index (BMI). The security must have increased ordinary cash dividends every year for at least five consecutive years, and the float-adjusted market capitalization of the security, at the time of the review, must be at least C$ 300 million.
Top 10 Holdings (19.95%)
iShares Canadian Select Dividend Index ETF (XDV)
This ETF seeks to replicate the performance, net of expenses, of the Dow Jones Canada Select Dividend Index. The index is comprised of 30 of the highest yielding, dividend-paying companies in the Dow Jones Canada Total Market Index, as selected by Dow Jones using a rules-based methodology including an analysis of dividend growth, yield and average payout ratio.
Top 10 Holdings (58.37%)
Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY)
This ETF seeks to track, to the extent reasonably possible and before fees and expenses, the performance of a broad Canadian equity index that measures the investment return of common stocks of Canadian companies that are characterized by high dividend yield. Currently, this ETF seeks to track the FTSE Canada High Dividend Yield Index. It invests primarily in common stocks of Canadian companies that pay dividends.
Top 10 Holdings (73.68%)
iShares Core MSCI Canadian Quality Dividend Index ETF (XDIV)
This ETF seeks to replicate, net of expenses, the performance of the MSCI Canada High Dividend Yield 10% Security Capped Index. The MSCI Canada High Dividend Yield 10% Security Capped Index targets companies from the Parent Index (excluding REITs) with high dividend income and quality characteristics and includes companies that have higher than average dividend yields that are expected to be both sustainable and persistent.
Top 10 Holdings (77.75%)
Conclusions
For your convenience, I’ve re-displayed the summary stats below:
Name
BMO Canadian Dividend ETF
iShares S&P/TSX Canadian Dividend Aristocrats Index ETF
iShares Canadian Select Dividend Index ETF
Vanguard FTSE Canadian High Dividend Yield Index ETF
iShares Core MSCI Canadian Quality Dividend Index ETF
Ticker
ZDV
CDZ
XDV
VDY
XDIV
Expense Ratio
0.35%
0.60%
0.50%
0.20%
0.10%
Yield
5.57%
5.24%
5.71%
5.17%
5.26%
% Financials
33.88%
25.26%
59.85%
58.30%
56.42%
% Energy
15.25%
9.64%
6.30%
30.00%
17.72%
% Top 10
30.00%
19.95%
58.37%
73.68%
77.75%
Judging by the sector exposures, XDV, VDY and XDIV provide more concentrated exposure to financials. VDY provides concentrated exposure to both financials and energy. If you desire an ETF more focused on financials and energy, VDY and XDIV are probably your best choice because of their exceptionally low fees.
The remaining dividend ETFs – ZDV and CDZ – provide a more diversified exposure to Canadian dividend paying stocks across a wider range of sectors. Although ZDV is a bit more concentrated in financials and energy, this provides it a yield boost. Finally, ZDV also charges a lower fee, making it my preferred ETF for broad exposure to a wide variety of Canadian dividend paying stocks.
I’ve met many people over the years who love their dividend stocks. They buy Canadian staples like Royal Bank, TD, BCE and Enbridge for their consistent, growing (usually) dividends.
If you’re an income investor, there’s nothing wrong with this for the equity portion of your portfolio. But there’s a way to get the fixed income side working harder – by using preferred shares.
Preferred shares are hybrid securities that pay dividends (often fixed). Preferred share dividends must be paid out before common share dividends, making them a more reliable source of income.
In the event of a dissolution or liquidation of the issuer, preferred shareholders’ claims on assets are senior to common shareholders but behind debt holders.
The share price of preferred shares can change significantly but tends to be more stable than common equities. This is a positive and a negative, depending on how you look at it. Preferred shares don’t participate in the upside profits from ownership of the company and usually have no voting rights unlike common shares. However, they might decline less than common equities from the same issuer in down markets.
Because preferred shares are often redeemable at a specified par value and pay a fixed dividend, they can have similar characteristics to bonds. Namely, they are more interest rate sensitive than common shares. Because of this, at times the prices of preferred shares can move in different directions to their common stock counterparts.
A big benefit over corporate bonds for Canadian investors using non-registered accounts is certain Canadian preferred shares are eligible for the dividend tax credit. (I.e. a 5% yield on an eligible Canadian preferred share is worth more after tax than 5% on a similar bond.) Another advantage over bonds is the higher pre-tax yield. Of course, this is because bonds are ranked higher in a company’s capital structure and tend to be less volatile.
As you can see, preferred shares are an asset class that belongs somewhere between stocks and bonds. As such, they can be used to fine tune a portfolio potentially replacing some of the equity or corporate bond portion, depending on an investor’s individual situation.
Warning: Over the long-run you’d probably be better off NOT using preferred shares as an equity substitute. They don’t participate in the upside – that’s a big tradeoff for an investor with a long time horizon.
There is a lot to look for when buying individual preferred shares:
Credit quality
Yield to call/redemption
Liquidity
Term to maturity – perpetual vs retractable
Payment provisions – fixed, floating, re-settable
Dividend policy – cumulative vs. non-cumulative
Other features
Ideally, a portfolio of preferred shares is diversified by issuer and type. Quite frankly the dumb/lazy investor like myself has no time or energy for this kind of research and maintenance. Instead, I prefer to use an ETF.
Below I’ve listed 3 of the largest preferred share ETFs that are traded on the TSX:
iShares S&P/TSX Canadian Preferred Share ETF (CPD)
This ETF provides exposure to a diversified portfolio of Canadian preferred shares and can be used to diversify sources of income beyond traditional government bonds and GICs.
Key facts (as at May 25, 2020):
Yield: 6.05% (trailing 12mth distribution yield)
Distribution Frequency: Monthly
Top 3 Sectors: Banks (35.83%), Insurance (20.98%), Energy (15.67%)
Management Fee: 0.45%
RBC Canadian Preferred Share ETF (RPF)
This ETF provides access to a diversified portfolio of rate-reset preferreds in a single ETF. The ETF is actively managed by investment teams with expertise in company-level fundamental research, credit analysis and interest rate forecasting.
Key Facts (as at May 25, 2020):
Yield: 6.81% (dividend yield)
Distribution Frequency: Monthly
Top 3 Sectors: Financials (59.70%), Energy (22.60%), Utilities (14.80%)
Management Fee: 0.53%
BMO Laddered Preferred Share Index ETF (ZPR)
This ETF is designed for investors looking for higher income from their portfolios. The ETF invests in a diversified portfolio of rate reset preferred shares and has lower interest rate sensitivity than the full preferred share market.
Key Facts (as at May 15, 2020):
Yield: 6.81% (distribution yield)
Distribution Frequency: Monthly
Top 3 Sectors (May 25, 2020): Diversified Banks (39.17%), Oil & Gas Storage and Transportation (21.43%), Life & Health Insurance (7.53%)
Many investors are starting to get interested in gold again. You can invest in gold by purchasing actual bullion (bars or coins) from a dealer, by buying a fund that holds bullion, by buying a fund that invests in gold mining companies or by buying a fund that gains exposure to gold via the futures market.
Personally, as a strategic holding I prefer to use exchange traded funds that buy and hold fully-allocated gold bullion. I want exposure to the underlying metal, not necessarily to the factors driving the success or failure of individual gold mining companies. However, during a gold bull market both can perform well.
For Canadian investors, below I have listed out the gold ETFs and closed-end funds that trade on the TSX. For your reference, I’ve also listed how they gain exposure to gold, asset size, ticker and fund manufacturer.
Note: This table is best viewed on desktop
Name
Ticker
Type
Market Value (Jan 31, 2020)
Fund Family
iShares Gold Bullion ETF
CGL
Bullion
$689,140,000
BlackRock/iShares
iShares S&P/TSX Global Gold Index ETF
XGD
Gold Miners
$907,998,000
BlackRock/iShares
BMO Equal Weight Global Gold Index ETF
ZGD
Gold Miners
$135,564,554
BMO
BMO Junior Gold Index ETF
ZJG
Gold Miners
$94,555,662
BMO
CI First Asset Gold+ Giants Covered Call ETF
CGXF
Gold Miners + Covered Calls
$57,766,925
First Asset
Harvest Global Gold Giants Index ETF
HGGG
Gold Miners
$5,136,000
Harvest Portfolios
BetaPro Canadian Gold Miners -2x Daily Bear ETF
HGD
Gold Miners
$24,607,586
Horizons ETF
BetaPro Canadian Gold Miners 2x Daily Bull ETF
HGU
Gold Miners
$139,311,700
Horizons ETF
BetaPro Gold Bullion -2x Daily Bear ETF
HBD
Gold Futures
$1,429,500
Horizons ETF
BetaPro Gold Bullion 2x Daily Bull ETF
HBU
Gold Futures
$15,318,750
Horizons ETF
Horizons Enhanced Income Gold Producers ETF
HEP
Gold Miners + Covered Calls
$84,782,850
Horizons ETF
Horizons Gold ETF
HUG
Gold Futures
$48,987,900
Horizons ETF
Horizons Gold Yield ETF
HGY
Bullion + Covered Calls
$36,623,848
Horizons ETF
Purpose Gold Bullion Fund
KILO
Bullion
$78,661,862
Purpose Investments
Sprott Physical Gold and Silver Trust
CEF
Bullion
$3,111,977,657
Sprott Asset Management
Sprott Physical Gold Trust
PHYS
Bullion
$2,476,809,556
Sprott Asset Management
Royal Canadian Mint – Canadian Gold Reserves
MNT
Bullion
$555,971,692
Royal Canadian Mint
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Today, the price per barrel of West Texas Intermediate reached a low of -$40.32. That’s right: the price was negative.
West Texas intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing.
Everyone has the same question: How is this possible?
The reality is that there is simply too much oil being produced right now and not enough demand. Production is being curtailed globally, but that takes time. It’s not like a light switch that can simply be turned on and off.
The chart below shows supply and demand for the world oil market going back to 2000. As you can see, most of the time there tends to be minor variance between supply and demand.
In contrast, today the gap between supply and demand is extremely wide. This means there is a massive surplus of oil being produced right now.
That oil needs to be stored somewhere, and as storage capacity is maxed out fewer people are willing to take delivery.
With May 2020 WTI futures contracts expiring on April 21, oil producers are desperate to offload about 100 million barrels. With limited storage and plummeting demand, producers are now forced to pay others to take the oil off their hands. Nobody wants to take delivery and the oil has to go somewhere.
You read that right. Oil producers right now must pay others to take delivery of their oil. Of course, anyone taking delivery must have somewhere to put it and means to transport it. That all costs money.
As the Covid-19 coronavirus economic catastrophe rages on, it is likely that energy markets continue to implode – at least until supply and demand can be more closely aligned.
Vanguard Energy ETF (VGE), Exxon (XOM), ConocoPhillips (COP), Chevron (CVX) and Canadian Natural Resources (CNQ) are getting hurt badly today. However, the United States Oil Fund (USO) is down even more, more closely reflecting the maturing May contract.
Beware if you’re considering buying an ETF that buys oil futures like the United States Oil Fund (USO). These types of ETFs shouldn’t be used to get long-term exposure to oil.
Oil ETFs tend to invest by purchasing futures contracts (i.e. they don’t actually buy barrels of oil). When a futures market is in “contango” (see chart below) futures contracts expiring near-term have a lower price than those expiring farther out into the future. The oil futures market is currently in record contango. Indeed, there is currently (mid-day April 20th) roughly a $50-60 spread between the May and June contract.
Even if prices along the futures curve for Oil remains constant, when the market is in contango an oil ETF that buys futures contracts will experience a negative roll yield as future contracts approach expiry and converge with lower spot prices. This is a great way to lose money over the long term. Oil ETFs that invest in futures contracts are best used for very short term trades.
If you are brave enough to invest in energy right now as a long term play, I would instead choose an ETF that invests in actual producers.
If you found this article helpful, please forward to a friend or colleague you think might benefit.
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Theoretical purists will hate this, but I love dividend stocks. I know total returns are what really matter in the end, but I truly appreciate the discipline forced on executives managing a dividend paying company. As an added bonus, there are also psychological benefits to owning dividend paying stocks.
Executives at dividend paying companies don’t want to cut their dividend. Consequently, they work harder to preserve and grow cash flow. They also are more likely to return excess cash to shareholders instead of spending it on pet projects and empire-building. I believe dividends enforce a level of discipline on corporate executives.
I believe dividends enforce a level of discipline on corporate executives.
Moreover, a tangible, growing cash return provides a psychological buffer to the unpredictable ups-and-downs of the stock market. An investor that believes he will continuously receive his dividends will be less likely to make emotional sell decisions when things get difficult. Things are difficult right now.
During the Covid-19 coronavirus crisis, stock prices have plummeted. As stock prices plummet dividend yields have exploded. (Dividend yield = $ dividend per share / share price) This has attracted the interest of many investors that read this blog.
Just look at the sexy dividends in the table below (as at April 1, 2020). But beware – high dividend yields are sometimes like a siren’s call, attracting yield-chasers to their doom.
Company
Dividend Yield
IBM
6.01%
3M
4.42%
TD Bank
5.83%
Altria Group
8.95%
While on the surface a high dividend yield can look appealing, there is much more that needs to be considered.
Dividends are not guaranteed. They can be reduced or even eliminated. It has happened many times and will continue to happen in the future.
Broadly-speaking, Goldman Sachs is predicting the aggregate of dividends paid by companies in the S&P 500 will decline in 2020. According to US equity strategists at Goldman Sachs, S&P 500 dividends will decline by 25% in 2020 compared to 2019. Since dividends have already risen so far this year by 9%, that implies between now and the end of the year, dividends will decline by 38%.
The market collapse is barely a month old and we’re already witnessing numerous dividend cuts and suspensions. Here are just a few:
Boeing: Dividend suspension
Marriott International: Dividend suspension
Ford: Dividend suspension
Delta Airlines: Dividend suspension
Freeport-McMoran: Dividend suspension
Darden Restaurants: Dividend suspension
Bloomin’ Brands: Dividend suspension
BJ’s Restaurants: Dividend suspension
Macy’s: Dividend suspension
Nordstrom: Dividend suspension
A&W: Dividend suspension
Occidental Petroleum: Dividend cut
Apache: Dividend cut
Targa Resources: Dividend cut
DCP Midstream LP: Distribution cut
Sabre: Dividend suspension
At the same time, there are other companies that have (more-or-less) publicly stated they will not cut their dividend. CIBC’s CEO, Victor Dodig, on March 31st made the following statement on BNN:
“Our goal is to make sure that those dividends are flowing…I’d say one thing that’s incredibly important: Canadian investors that invest in our banks rely on those dividends for income. And every source of reliable income that we can provide to Canadians – and Americans, and our other shareholders that are investing in our banks – is incredibly important in this moment in time where cash flow reduces anxiety.”
So how are you supposed to know a dividend is secure?
You don’t.
Dividends – like price returns – must be viewed as uncertain. The likelihood of a future dividend exists on a scale of probabilities. Some are less likely to continue, others are more likely. Fortunately, there are ways to help identify dividends that are more likely to be paid in the future.
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Use history as your guide
Some companies have paid dividends for decades. In the US, “Dividend Kings” are companies that have consistently paid their dividends for over 50 years. Here’s a recent list of these companies.
Management at companies with a long history of paying dividends are more likely to do everything they can to protect the dividend. 1) No CEO wants to be the one to break a multi-decade track record. 2) After decades of protecting the dividend, shareholder cashflow management becomes part of the corporate culture and design. 3) A company that has consistently paid a dividend throughout previous crises is likely in an industry with relatively steady demand and predictable margins (compared to other industries).
Avoid dying industries
You could own shares of the best run company with a management team committed to paying a dividend, but if that company is in a deteriorating industry the dividend still might get cut. Remember record companies, newspapers and magazines?
You could own shares of the best run company with a management team committed to paying a dividend, but if that company is in a deteriorating industry the dividend still might get cut.
The challenge is that many companies in industries with a potentially big future (e.g. Tesla) don’t pay dividends. Companies in these industries might be growing fast, but they don’t yet have a stable source of cashflow. Instead, most dividend investors focus on are mature industries that will continue to stand the test of time – telecommunications, consumer non-discretionary, utilities, banks.
You’ll notice I didn’t include the energy industry. While this industry is mature and critical to the economy, it is highly cyclical and subject to the whims of the commodities markets. While there may be a place for energy companies within a dividend portfolio, I would consider these to be at the riskier end of the spectrum.
Find companies with cash to pay their dividends
When choosing dividend stocks, pick companies that can actually pay their dividends. This sounds like common sense, but when the high-yield sirens call many forget this.
Unlike many other items on financial statements, dividends aren’t some kind of accrued line-item. To pay a cash dividend a company must actually have cash. For a dividend to be sustainable, that cash must come from earnings. (Believe it or not, many companies finance their dividend payments by borrowing money.)
While I wouldn’t expect anyone to trace the origins of where a cash dividend came from, a simple measure can provide some guidance. The dividend payout ratio (annual dividend per share / annual earnings per share) indicates the proportion of earnings paid out as dividend. While companies in more stable industries can handle higher payout ratios, generally a payout ratio below 50% of earnings is very comforting to me.
Who is competing for your cash?
Stockholders get paid last. They receive the remnants of cash left over after interest payments on debt. Technically-speaking, debt is higher on the capital structure than equity. This means stockholders don’t get paid their dividends until after bondholders have received their coupons.
For this reason, when investing in a dividend paying stock you need to understand how debt affects a company’s cashflows. Conveniently, the dividend payout ratio somewhat bakes this into the calculation, since earnings per share shows what’s left after debtholders have been paid.
Still, it helps to understand how indebted the company is. This requires a bit of homework, but dividend investors should pay attention to a company’s debt-to-assets and interest coverage ratios. A heavily indebted company – especially one in a cyclical industry – will have a much harder time committing to dividend payments.
Yes, I have a life and day job
I don’t have hours a day to dive into company financials. The most prudent way to proceed is to assume at least some investments will at some point cut or suspend their dividends. (Mitigating unavoidable mistakes is part of the entire premise of DumbWealth.com.) My simple workaround is, within the equity portion of my portfolio, to diversify by spreading a portfolio across 20-30 dividend paying stocks and a range of industries.
This can be done by purchasing individual stocks or by buying an ETF that invests in dividend paying stocks.
Personally, for my long-term buy-and-hold investments I prefer to own the actual stocks. That way I avoid any perpetual fees associated with an ETF. However, this strategy would not make sense if my portfolio was small (say less than $20-30k) or if I had a shorter time horizon.
Please let me know below if you have any questions!
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The Covid-19 economic crisis is gripping the world. After 20 years in the asset management business, it looks like we are fighting through unprecedented territory.
This is war. I created a 17 step, 47 page guide to help DumbWealth subscribers get through this.
I originally planned on printing the guide and selling copies for $20+. Instead I’m giving this away free because I think we all need to help each other during these difficult times.
Dig gold? Gold is hot again and the number of supporters is quietly on the rise. Famously, billionaire investors Ray Dalio and Jeff Gundlach have both recently announced their support for the metal but there are many others coming out of the woodwork. After a multi-year hiatus it seems like the case for gold is strong again.
“…the world is leveraged long, holding assets that have low real and nominal expected returns that are also providing historically low returns relative to cash returns (because of the enormous amount of money that has been pumped into the hands of investors by central banks and because of other economic forces that are making companies flush with cash). I think these are unlikely to be good real returning investments and that those that will most likely do best will be those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold. Additionally, for reasons I will explain in the near future, most investors are underweighted in such assets, meaning that if they just wanted to have a better balanced portfolio to reduce risk, they would have more of this sort of asset. For this reason, I believe that it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio.”
I have also illustrated the case for holding gold in my article “The 60/40 Portfolio is Dead“. In this article I looked at various portfolios (some including gold, others not) across different investing paradigms.
The past 40 years benefited from the tailwind of declining inflation and interest rates. Clearly, with interest rates near zero today, what worked over the past 40 years won’t work over the next 40 years. So I examined these portfolios going back to 1970 when inflation and interest rates were rising. When examined across both investing paradigms, Gold exposure was shown to stabilize returns and reduce downside.
Canadian investors looking to buy gold first have to decide whether they want to own gold mining stocks or gold bullion. My preference is gold bullion since it is a pure play on the price of gold. In contrast, gold mining stocks are influenced by extraction costs, equity risk premiums and management decisions, in addition to the price of gold. However, gold miners can be used as a leveraged play on gold since they tend to rise and fall faster than the actual metal.
For my portfolio construction purposes, an allocation to gold bullion makes the most sense.
There are a number of ETFs in Canada that buy and hold actual gold bullion stored in vaults. There are also ETFs that gain exposure by purchasing gold futures contracts. I prefer a fund that owns bullion to gold future contracts because I don’t want exposure to the added complexities introduced by the the futures market (e.g. counterparty risk, negative roll yield).
What Gold Bullion ETFs Exist for Canadian Investors?
Below I have identified 4 low cost gold bullion ETFs available on the TSX. Note that some are hedged and some are not. For a Canadian investor, owning an unhedged gold ETF, in my opinion, is the purest way to own the metal:
I have cash I need to tuck away for a while. I’ll probably need this cash in under two years (could be in 2 months, could be 2 years…timing is unpredictable in this case). So what do I do?
Standard Bank Accounts Pay Crap
Deposit rates for standard accounts at the major Canadian banks are minuscule. So that’s not an option, unless I want to see my cash get eroded by inflation (recently reported as 2.4% in Canada).
My next option is some of the bank alternatives like Motive Financial or Simplii Financial. If you time it right you can open an account or GIC with a big-bank alternative and get a rate between roughly 2-2.8%. B2B Bank seems to lead with a 3.3% rate on a savings account.
I think these are all excellent choices. However, opening an account and transferring money can be a bit of a hassle. Moreover, accessing large amounts of money (i.e. more than allowed at most atms) from these accounts probably either requires linking accounts or using cheques. It’s no Manhattan Project, but it does require time and effort. I just want to park my cash, earn a little money and withdraw the whole lot when I need it.
Introducing: PSA and CSAV
I found two other options I can easily access within my existing online discount broker. No account openings required. Simply buy/sell an ETF. The two ETFs I’m referring to are PSA (Purpose High Interest Savings ETF) and CSAV (CI First Asset High Interest Savings ETF).
These two ETFs are similar in many ways. They both pool investor money and invest in high interest savings accounts at various financial institutions. Because of the volume of cash at play, I presume they have negotiating power and can get decent rates. While they don’t yield as much as some bank alternatives, they do produce a respective cash flow, as shown in the table below.
PSA
CSAV
MER
0.16%
0.15%
Distribution Frequency
Monthly
Monthly
Last Distribution
$0.0987
$0.0801
Forward 12mth Distribution Yield
2.369%
1.922%
Risk of Underlying Insolvency?
The ease and speed of accessing high interest savings yields via a simple trade appeals to me. However, I wonder if there might be a downside.
Because an ETF (an institutional entity, as opposed to an individual) is putting money into various bank deposits my understanding is the underlying deposits do not qualify for CDIC insurance. So with the very small risk that an underlying bank becomes insolvent there is a remote chance that an underlying deposit is not honoured.
While this is a small probability, it can also be a catastrophic risk for someone putting a large amount of their wealth into one of these ETFs.
One only has to go back a decade to find a time when banks were teetering on insolvency. So insolvency is a non-zero possibility. With CDIC insurance, deposits are back-stopped by the Federal Government (indirectly the printing presses at the Bank of Canada). Without CDIC insurance, depositors are left on their own.
One way to mitigate this risk is to diversify. It’s no different than diversifying away idiosyncratic risk of individual companies in a stock portfolio. If one holding blows up, hopefully the others remain intact.
The pie charts below show the latest holdings breakdown of PSA and CSAV, using their most recent Fund Facts documents. As you can see, PSA has a disproportionate amount (80%) in just two financial institutions – National Bank and Scotia Bank. In contrast, CSAV holdings are evenly distributed across five banks. I think it is fair to question why PSA is so concentrated.
Don’t get me wrong. I’m not saying either of these ETFs are particularly high risk at the moment. However, I do think it is noteworthy that 1) these types of investment structures are untested during a financial crisis, and 2) the asset allocation profiles of these two ETFs are so different.
Canadian banks appear to be well capitalized and stable. But with the extremely high debt-to-income ratios within Canada I fear something could someday unravel, leaving banks vulnerable. Are banks and uninsured depositors prepared for a tail-risk event? That’s another fair question.
Risk of Run on Deposits?
PSA and CSAV have a combined $3.7 billion in deposits (CSAV alone has gathered $1.3b in assets since June 2019) at a variety of banks. These asset levels are growing rapidly because these ETFs are popular.
I wonder if there could eventually be a mis-match of liquidity (remember, banks use deposits to fund their operations and are reliant on the assumption that depositors won’t all withdraw at the same time) if investors were to suddenly sell the ETFs en masse.
While such a scenario is unlikely, bank runs do happen. The ease at which investors could sell their ETF holdings almost instantaneously could pose a risk to the banks that provide deposit services to the ETFs. This is a long way of saying that I believe Canadian security regulators may permit these ETFs to suspend redemptions if the redemptions pose a systemic risk to the Canadian financial system via a run on deposits at a particular institution. This is another improbable but very inconvenient risk if it were to occur.
In the end I decided to still use both these ETFs (in addition to a short term bond ETF) to park my cash while I investigate the risks further. Maybe I’m wrong but I believe the questions raised in this article deserve answers. In fact, I really hope someone shows me that the real risks are a lot lower than I suspect, because I think these ETFs provide good value to investors looking to park cash. The ability to easily and quickly invest in a range of high interest savings accounts really is quite innovative.
I will update as I uncover more answers. Stay tuned…
A big part of building wealth involves controlling what you can control. After all, there are so many things outside of your control that affect your ability to build wealth – promotions, unexpected illness and investment returns.
With respect to your investments, cost is one of the big controllable factors. And that one factor can have a large influence over the long term accumulation of wealth.
Luckily, today we have many inexpensive ways to get exposure to the markets.
The following list shows some of the cheapest ETFs that provide exposure to the Canadian equity market. The ETF name is followed by its ticker symbol, management fee and primary objective.
Horizons S&P/TSX 60 Index ETF (HXT) – 0.03%
Horizons HXT seeks to replicate, to the extent possible, the performance of the S&P/TSX 60™ Index (Total Return), net of expenses. The S&P/TSX 60™ Index (Total Return) is designed to measure the performance of the large-cap market segment of the Canadian equity market.
iShares Core S&P/TSX Capped Composite Index ETF (XIC) – 0.05%
The ETF seeks to provide long-term capital growth by replicating, to the extent possible, the performance of the S&P/TSX Capped Composite Index (the “Index”), net of expenses. Under normal market conditions, the ETF will primarily invest in Canadian equity securities. The Index is comprised of a selection of the largest (by market capitalization) and most liquid securities listed on the Toronto Stock Exchange, selected by S&P Dow Jones Indices LLC using its industrial classifications and guidelines for evaluating issuer capitalization and liquidity.
BMO S&P/TSX Capped Composite Index ETF (ZCN) – 0.05%
The BMO S&P/TSX Capped Composite Index ETF has been designed to replicate, to the extent possible, the performance of the S&P/TSX Capped Composite Index (Index), net of expenses. The ETF invests in and holds the Constituent Securities of the Index in the same proportion as they are reflected in the Index.
Vanguard FTSE Canada All Cap Index ETF (VCN) – 0.05%
The fund seeks to track, to the extent reasonably possible and before fees and expenses, the performance of a broad Canadian equity index that measures the investment return of large-, mid- and small-capitalization, publicly traded securities in the Canadian market. Currently, this Vanguard ETF seeks to track the FTSE Canada All Cap Index (or any successor thereto). It invests primarily in large-, mid- and small-capitalization Canadian stocks.
Vanguard FTSE Canada Index ETF (VCE) – 0.05%
The fund seeks to track, to the extent reasonably possible and before fees and expenses, the performance of a broad Canadian equity index that measures the investment return of publicly traded securities in the Canadian market. Currently, this Vanguard ETF seeks to track the FTSE Canada Index (or any successor thereto). It invests primarily in the largest Canadian stocks.
