(Sept 25): Dividend-focused exchange-traded funds have long been popular among investors in the US. These ETFs tend to have higher dividend yields as well as regular distributions, making them popular among retirees and those seeking an income addition to their portfolios.

Such ETFs have not gained as much traction among Singapore investors, says Grandtag Financial Consultancy CEO Ben Fok. But this could change as more of such products are rolled out. This past year, there were two new offerings for investors. Last October, Phillip Capital Management launched the Phillip SGX Asia-Pacific Dividend Leaders REIT ETF. This was the first real estate investment trust ETF to list on the bourse. In May, Thailand-based One Asset Management made its maiden foray into Singapore with a smart-beta ETF: the One STOXX Asean Select Dividend Index Fund.

Both ETFs join two others that have been listed on the Singapore Exchange for some time: Deutsche Asset Management’s db x-trackers STOXX Global Select Dividend 100 UCITS ETF, which was listed in 2010; and the CIMB S&P Ethical Asia Pacific Dividend ETF, which was listed in 2012.

The db x-trackers ETF is synthetic and classified as a Specified Investment Product, which means it can be bought and traded only by those who pass a customer knowledge assessment. The others are physical ETFs classified as Excluded Investment Products, and are accessible to all retail investors.

According to Bloomberg data, the CIMB ETF has the highest one-year annualised return of 24.9%. But the db x-trackers ETF has produced higher three- and five-year returns of 3.6% and 6.9%, respectively, outperforming both the CIMB ETF and the Straits Times Index.

Past performance is not, of course, a predictor of future returns. Meanwhile, the Phillip and One ETFs do not have sufficient historical data for comparisons of returns to be made. So, how should investors decide which dividend ETF to put their money into? Financial advisers who spoke to The Edge Singapore recommend looking at how the ETF selects its constituents, as well as the method it uses to replicate the index it tracks.

Screening for yields and more Not all dividend ETFs define high-yielding securities in the same way. Some ETFs place a general emphasis on stocks with the potential for both dividend yield and capital growth. But Victor Wong, director of wealth management at Financial Alliance, says others come with more specific criteria and are well worth paying attention to.

The db x-trackers ETF, for instance, is based on the STOXX Global Select Dividend 100 index. The index screens for stocks that have a non-negative historical five-year dividend- per-share growth rate. “This criterion first aims to select stocks that are able to increase their dividend payout over the longer run,” says Marco Montanari, Asia-Pacific head of passive asset management at Deutsche Asset Management. “After meeting this criterion, companies are then ranked and selected for the highest yields based on STOXX’s methodology.

“Investors buying the ETF aim to gain exposure to dividend-yielding companies, and this index criterion helps direct the selection towards such company exposure,” he adds.

Screening for historical growth in dividend payouts can serve investors well, Wong says. “Yield on its own is not enough, the growth in yield should be stable,” he explains. “Most people would also want the dividend payouts to be in line with inflation.”

Screening for dividend growth has tended to limit the downside for investors in the US-listed ProShares S&P 500 Dividend Aristocrats ETF too. This ETF tracks an equal-weighted index of 50 Standard & Poor’s 500 constituents that have increased their dividend payments annually for at least 25 years. In a Sept 7 report, Phillip Securities analyst Ho Kang Wei notes that over the last two major market crises, the ETF fell significantly less than the S&P 500 index, recovered faster and continued paying out ever-increasing dividends.

Some ETFs also have additional criteria to ensure the growth potential of the companies they invest in. The index that the db x-trackers ETF tracks further limits its constituent stocks to those that have a dividend-to-earnings per share ratio not exceeding 60% or 80%, depending on the region. Similarly, the One ETF does not include stocks that have a dividend payout ratio above 80%.

This is a “sound strategy” that can ensure that the company is not paying out more than it can earn in the short term, Wong says. It should also make for more sustainable dividend payouts in the future. This could be especially important for a fund such as the One ETF, which is banking on the Asean growth story. The fund tracks and fully replicates the STOXX Asean Select Dividend 30 Index, composed of stocks listed in Malaysia, Singapore, Indonesia, Thailand, the Philippines and Vietnam. All the constituents are equally weighted.

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Beyond yields, Grandtag’s Fok notes that ETFs that screen for companies with a certain valuation or trade volume can better ensure liquidity and reduce volatility. The STOXX Asean Select Dividend 30 Index is limited to stocks with a three-month average daily trading volume above US$2 million ($2.7 million). The Phillip REIT ETF, which tracks the SGX APAC ex Japan Dividend Leaders REIT Index, allows only for constituents with a minimum free-float market capitalisation of US$300 million.

Then, there are other screening tests that may be significant to certain groups of investors. The CIMB ETF, for one, was specially designed for the ethical investor. The fund, which tracks the S&P Ethical Pan Asia Select Dividend Opportunities Index, includes only stocks that have less than 5% revenue exposure to tobacco, alcohol, gaming and pork. The 40 stocks in the Pan Asian region with the highest dividend yields that meet this requirement are then included in the index and replicated in the fund.

Meanwhile, the Phillip REIT ETF, was created for investors seeking stable payouts from REITs, says Tan Teck Leng, a senior fund manager with Phillip Capital Management. The ETF has a high representation of Asia-Pacific ex-Japan REITs, which Tan says offer “comparatively higher dividend yields” than those in the US and UK. Its constituents are weighted by the dividend payout of the REITs.

“The current low interest rate environment warrants that investors seek yield from instruments other than bonds. We think REITs are a good alternative to high-yield bonds, with an easy-to-understand business model, coupled with regular dividend payments,” Tan says.

The criteria each ETF uses to select its constituents are ultimately unique to the fund’s objectives and cannot be directly compared against one another, Wong says. Investors will need to reflect on what their priorities are and how much risk they are willing to take on.

Physical or synthetic: Understanding the risks A potential pitfall of dividend ETFs is that in seeking higher yields, investors may inadvertently take on more risk. Wong says it therefore pays to closely examine the structure and replication methods of each ETF.

Of the four dividend ETFs, the db x-trackers ETF is perhaps the most complex product. The ETF “aims to reflect the performance of its reference index through synthetic replication”, says Deutsche AM’s Montanari. According to the fund’s prospectus, it may enter into unfunded swaps with approved swap counterparties. Its depository is State Street Bank Luxembourg.

While the structure may be “sound”, synthetic ETFs expose investors to greater counterparty risks. This could be especially risky in the event of unexpected financial calamities such as the 2008 subprime crisis, Wong says. “If there’s a choice between physical and synthetic, I would say maybe go for physical, because it’s less complex and can give you more peace of mind. For markets that are hard to access, such as emerging and frontier markets, a synthetic ETF may be your only choice. But if you want global exposure, it’s simpler to choose a physical ETF,” he says.

Currency risk is another factor that investors should look out for when putting their money in overseas ETFs. Says Wong: “Every time you put money outside Singapore, you must think whether foreign exchange rates will wipe out the gain.” To hedge against currency risks, it helps to look at an ETF’s hedging policy. The One fund, for instance, may use derivatives to hedge against currency risk.

It also helps to be aware of whether the ETF does securities lending. The Phillip REIT ETF, for instance, may lend securities or engage in repurchase transactions as part of its portfolio management strategy, although such moves will be limited to 50% of the net asset value of the fund.

While securities lending comes with extra risks, Fok says it can also enhance investors’ returns while reducing management fees. “That is why some lowfee ETFs can beat their benchmarks,” he says. “On the flip side, if the ETF holds stocks that are hard to borrow, that may attract higher lending fees while eroding your return.”

Overall, Wong says investors should be keenly aware of their risk appetite and invest accordingly. He believes REIT ETFs are well positioned to pay out regular dividends. “REITs have to pay out 90% of their profits as dividends, so the certainty of the yield will be greater. Those who really want to go for dividend [payouts] will naturally go for a REIT ETF.” But he acknowledges that different investors will have different priorities, with some optimistic about the rise of Asean and others opting for global exposure instead.

Dividend-paying securities are generally popular with Singaporeans, which suggests that dividend ETFs may eventually catch on. Wong predicts that this asset class may also come to be seen as a safe haven during downturns. “When the market is going up, it’s easier to make money through country- or sector-based ETFs. But when the market is coming down or a bit more volatile, perhaps dividend-focused ETFs would be the theme of the day,” he says.

Dividend ETFs may also become popular with an ageing population, as people add high-yielding funds to build a retirement portfolio. For this trend to eventually take shape, however, Wong reckons that we may have to wait for more dividend ETFs to be listed on the SGX, giving investors more options to choose from.

“Ultimately, it’s a chicken-and-egg scenario,” he says. “We need more choices for there to be more interest in dividend ETFs.”

Looking for a high-yield dividend-paying ETF? Pick one with growth emphasis

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