What Does Your Income ETF Focus On?

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The recent surge in popularity of high yielding investment avenues is not at all surprising, considering the desire for income in this low rate environment. Fortunately, there are a number of options available to investors from the ETF space to focus on income.

While some of these ETFs provide a pure play in the income investing space, others have a more holistic approach. There are those which focus on income as well as appreciation, and thus could be the best of both worlds.

Also, there are some others funds which do not limit themselves to a particular asset class in order to generate steady streams of income (read Junk Bond ETF Investing: Is It Too Late?).

With all this being said, it becomes extremely important for investors to dive deep into the strategy employed, as well as the holdings, expenses and performance of the prospective income ETFs before choosing an investment option. In this article we compare three ETFs, all of which primarily aim to generate income, but are quite different in terms of strategy as well as their risk-return tradeoff.

The ETFs in consideration are the, SPDR S&P Dividend ETF (SDY), Vanguard Dividend Appreciation ETF (VIG) and the Guggenheim Multi Asset Income (CVY).

Equity Income ETFs and Their Strategies

SDY and VIG primarily focus on equities which have established a historical trend of increasing their dividend payouts. For SDY, a stock has to increase the dividend payout for at least 20 consecutive years, whereas for VIG, this period in consideration is around 10 years (read Two Niche ETFs Beating SPY).

No matter how similar the strategy sounds, it actually has tremendous impact on the underlying performance. This is because, for a stock to consistently increase its dividend payout, the fundamentals have to be extremely positive.

In fact, one could argue that the more consistent a company is with its dividends, the better its underlying fundamentals and operations are, which could enable it to generate steady returns.

Having said this, the consistency factor is better suited for SDY than VIG, since the consistency requirement for a stock to be selected in SDY portfolio is around double than that of VIG i.e. 20 years as opposed to 10. In other words, it would be safe to argue that SDY picks stocks of companies with a longer and more established consistency trend.

Enter the Multi asset ETF

As far as CVY is concerned, it is exposed to a variety of asset classes. CVY has exposure to high yielding equities, MLPs, REITs, and preferred stocks.

It also gains exposure in various closed ended funds (CEFs) as well as ADRs of high yielding foreign companies (see Is CVY The Best Income ETF?).

In short, it provides a more holistic approach to investing. Also, another worthwhile consideration in this regard would be the fact that CVY would be free from any currency risk as the ETF holds only U.S. dollar denominated assets. This is despite having exposure to assets having an international flavor.

Consistent Performers: Best of Both Worlds?

Consider the following two charts. The first chart depicts the 5 year comparative performance of the three ETFs in terms of total returns whereas the second chart measures the comparative performance excluding the dividend component in total returns.

Chart 1: Comparative Total Returns

Chart 2: Comparative (excluding Dividends)

Not surprisingly, SDY is seen outperforming VIG and CVY, both in terms of total returns as well as the appreciation only (i.e. excluding dividend) parameters. This supports the ‘more consistent performers in SDY portfolio’ argument that we put forward in the earlier part of the article.

This is because the stocks in the portfolio of SDY have not only outperformed in terms of dividend payments, but their consistent performance has also priced in the sentiment factor that investors show towards fundamentally strong consistent performance. This is evident by the capital appreciation (see HYLD: Crushing the High Yield ETF Competition).

The following table summarizes the risk return tradeoff of the three ETFs

 

Returns Profile

ETFs

Total Returns

Capital Appreciation

Dividends

SDY

48.04%

23.64%

24.40%

VIG

35.44%

20.91%

14.53%

CVY

39.90%

3.36%

36.53%

Risk Profile (Volatility)

ETFs

5 Year Annualized

3 Year Annualized

SDY

26.57%

16.00%

VIG

21.91%

16.00%

CVY

27.58%

15.40%

         

Here again we see SDY comfortably beating VIG in capital appreciation as well as dividends. However, a closer look at the traits of CVY reveals some very important facts. It almost entirely depends on dividends in order to fetch returns.

This is primarily due to its large focus on income generating sources and less on pure play equities which provide little appreciation but robust dividends (read Gold ETFs in Focus: When to Consider GLDI).

In other words, shares worth $100 of CVY might only appreciate to $103.36 in 5 years’ time which is almost nothing compared to the equity ETFs. But in these 5 years, the $100 investment would yield $36.53 in dividends. A very important fact indeed, especially for investors dependent on a timely and steady stream of cash flows and less focused on growth.

The Bottom Line

The investment choice would almost entirely depend on the requirement of the investors. For example, as we can see, investors seeking more of current income and less of growth over the longer term would be better off playing CVY.

However, for others seeking more of growth and relatively lower levels of steady cash flows, any of the equity focused funds would be better choices. Either way, it is clearly important to know what is inside your income ETF and how it goes about buying securities, as this can have a huge impact on overall returns.

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Read the analyst report on SDY

Read the analyst report on CVY

Read the analyst report on VIG

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