Are dividend ETFs redundant?

Posted by admin on October 14, 2009 in Dividends

Numerous studies have found that the number of dividend paying stocks continue to decline. Not surprisingly, this has resulted in an increasing concentration of dividend paying stocks in large cap indexes as medium to small cap indexes tend to have members with characteristics not conducive to paying shareholder dividends: mainly lower profitability and less reliable earnings given relative immaturity in the business cycle.

The implication being that an overlap exists between broad based equity indexes and dividend paying stocks. But, just how large is the overlap?

The U.S. is considered one of the two countries (Japan being the other) where dividend concentration is less pronounced. However, if one purchased the Vanguard Large Cap ETF (VV) and the Vanguard High Dividend Yield ETF (VYM), of the top 50 holdings of each, there are 24 stock in common. This includes a staggering 19 of the top 20 holdings in VYM by weight.

Similarly, if one purchased iShare’s flagship Cdn. Large Cap 60 Index Fund (XIU) and iShare Cdn. Dividend Index Fund (XDV), one would find 15 of the 30 stocks compromising XDV are also found in XIU. This figure has more context if one considers that the overlap constitutes over 60% of XDV by weight.

The result is that one is not diversifying by investing in a large cap ETF and a dividend based ETF. Instead, an investor has merely created a redundancy in their portfolio and failed to mitigate against downside risk.

The issue becomes magnified if that same investor commits mutual fund-itis and begins purchasing niche ETFs which overlap the broader equity based ETFs. The ETF pairings to watch for in particular would be purchasing a broad based equity ETF and then a financial services industry ETF and/or preference share ETFs. Given the latter are typically issued by the same companies that pay dividends, if they can’t make a preference share dividends, which typically ranks in priority to common share dividends, they are not paying any class of shareholders a dividend.

The lesson being, and as a preview to a post next week, choice and selection are often not the best thing for the investor.

6 Comments on Are dividend ETFs redundant?

By Best Dividend Investing Posts of the Week – October 16, 2009 | The Dividend Guy Blog on October 17, 2009 at 7:06 am

[...] dividend ETFs [...]

By Book Winners and Weekend Reading – Oct 17, 2009 | Million Dollar Journey on October 17, 2009 at 10:10 am

[...] Are dividend ETFs redundant? @ Thicken My Wallet [...]

By Curious on October 18, 2009 at 5:46 pm

So let me ask a silly question…

If I own XIU, I’m essentially getting the same dividends from the companies that are captured in both XIU and XDV? For example, the same dividends from the companies would be paid out as a distribution through XIU. In other words, one isn’t missing potential dividends from a company just becuase it is in XIU ETF rather than “owning” it through the XDV ETF. I guess the total yield will be lower in XIU just becuase it’s focus is not on dividends exclusively; and will hopefully appreciate through growth of the ETF share value rather than just yields.

By admin on October 18, 2009 at 11:10 pm

Your analysis is correct. You would be obtaining dividends in a stock that was held in both XIU and XDV and the dividend yields in XDV tend to be higher than in XIU.

By Thicken My Wallet » Blog Archive » Does choice affect asset allocation? on October 19, 2009 at 5:05 am

[...] Comments admin on Do I have rights as an employee when my company goes bankrupt?admin on Are dividend ETFs redundant?Curious on Are dividend ETFs redundant?John D on Do I have rights as an employee when my company [...]

By Weekend Financial Roll Call :: Ending the Rat Race on February 6, 2010 at 3:11 pm

[...] Thicken My Wallet, posted the first of a two post mini-series asking “Are Dividend ETFs [...]