Friday, 31 January 2014

How does RBC's new Canadian Dividend ETF compare?

The ETF market in Canada took another step towards greater competition this month with RBC's launch of five new equity dividend-oriented ETFs, covering Canada, the USA (a US dollar version and a Canadian dollar hedged version) and developed countries (EAFE in both a US dollar and Canadian dollar hedged version).  Today we'll compare the ETF for Canadian equities, the RBC Quant Canadian Dividend Leaders ETF (TSX: RCD), which started trading January 15, 2014, with its competitors. We'll also see how these ETFs are faring against each other and the broader Toronto Stock Exchange.

RBC Quant Canadian Dividend Leaders ETF
Our comparison table below shows the numbers that lead us to say that RBC's new ETF has:
  • Low MER - At 0.39% maximum management fees (it isn't clear from the prospectus whether the cap on fees means only the management fee only or all the fund expenses as well, like legal, administrative, trading etc which, if not capped, might mean MER around 0.45%), this is second lowest to Vanguard's ETF of 0.35%.
  • Fairly conservative dividend seeking - This ETF does not look to be chasing the highest yielding stocks - e.g. only 2% of its portfolio yields more than 8%. It also has about the same proportion of companies that have cut or not increased their dividend as the TSX, as represented by two market benchmark ETFs, the iShares S&P TSX 60 (TSX: XIU) and the iShares S&P TSX Capped Composite (XIC). However, RCD is not entirely conservative since it has a fairly high proportion of companies with high dividend payouts (more than 90% of cash flow) and with dividends greater than trailing twelve month earnings. 
  • Low individual company concentration - Despite not having an explicit cap on concentration, the portfolio as of now is spread out - the top 10 stocks make up only 31% of the total value of holdings, which is at the low end of the spectrum.
  • Similar company size to the TSX Composite - It is among the closest of the ETFs to the benchmark XIC in terms of the average market cap of its holdings. 
  • High concentration in financials and energy - Offsetting somewhat the good risk spreading across companies, there is still a somewhat uncomfortably high proportion of 70% of holdings in just two sectors. Only Vanguard's FTSE Canadian High Dividend Yield Index ETF (VDY) has a higher sector concentration.
The other Canadian dividend ETFs

Dividend ETFs - Portfolio Characteristics

Dividend ETFs - Performance

Dividend ETF performance is impressive but surprising
  • Total return out-stripping TSX by a lot - Over the year 2013, all but one (BMO's ZDV) of the dividend ETFs outperformed both the large cap XIU or the Composite XIC, most by 3% to 7%. A lot of the return came from capital gains since the difference in dividend yield was nowhere higher than 2.2% (ZDV's 4.9% vs XIU and XIC's 2.7%). One supposedly dividend fund, Vanguad's VDY, actually yielded less at 2.6%, than the TSX! But its capital gains far outpaced the TSX and it was the highest return fund of all. The dividend ETF return advantage manifested itself consistently for those funds - HAL, XDV and CDZ - with a longer history of 3 or 5 years. This is not just one or two sectors, like financials or energy, doing especially well. XDV achieved the outperformance with a high concentration in financials and energy while CDZ achieved it with a markedly lower concentration in those sectors. We note in passing, though again the time frame is too short to be sure, that these results conform to the general findings about superior returns from dividend stocks that we wrote about last July
  • Volatility of dividend ETFs is less than the TSX - The numbers on beta, which measures sensitivity to moves of the overall market where a beta of 1.0 equals the market (i.e. XIC) and under 1.0 is less volatile, show that almost all the dividend ETFs are significantly less volatile than the TSX. The figures on absolute volatility of each ETF as measured by standard deviation of its returns compared to XIU and XIC indicate the same result. The Sharpe Ratio, which measures return over standard deviation, i.e. the higher the ratio the better, shows that most of the dividend ETFs did much better than both benchmarks during 2013. More return, less volatility risk, that's a good place to be, if it keeps up.
  • Some of ETFs' distribution (aka dividend) increases did not keep pace in 2013 - What surprised us even more is that several dividend ETFs in our list did not increase their cash distributions, because their holdings did not, as much as the benchmark ETFs. XDV, XEI, DXM and PDC had significantly lower distribution rises from 2012 to 2013 than either XIU or XIC. 
  • Long term distributions of XDV and CDZ are rising nicely - Perhaps what is most important for the investor seeking the higher distributions is the possibility that such higher distributions can be maintained in the long run. That seems to be the case so far for the two ETFs with the longest track record as the graph below shows. XDV has maintained its lead over XIU and CDZ, after a big drop in 2010 and 2011 when the big banks fell afoul of CDZ's selection criteria by not increasing dividends, seems to be recovering strongly.

Which Dividend ETF is best?
We still don't like HAL much for its high MER, lack of visibility (it doesn't publish its full holdings) and lower distribution rate, nor VDY which looks more like a value-oriented capital appreciation fund. It's hard to pick amongst the rest - good points of each one are offset by some weak points. ZDV would still be a slightly preferred option for those whose purpose in looking to this kind of ETF is to obtain high steady income. It had the highest trailing distribution yield, the tied highest forward looking distribution yield and the second highest increase in distributions in 2013. CDZ is an alternative for a mainstream type equity holding with a slightly higher dividend and perhaps/probably/hopefully better long term returns but the same risk characteristics as the overall market.

Disclaimer: This post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.


Anonymous said...

Thanks for your article. What's your view on the new Dividend ETF from Purpose (i.e.: PDF.TO) ? It's not a pure Canadian Dividend ETF as it has about 70% canadiand and 30% US companies.

CanadianInvestor said...

Hi Anon,
PDF looks ok and comparable to the pure Canadian ETFs for Canadian holdings. Its holdings overlap to a high degree and its expense ratio is reasonable at 0.55%. There is a measure of USD currency exposure inherent in it - as CAD goes down, return gets boosted and the other way round if CAD rises. PDF does offer the advantage of not having to trade currency, and pay the conversion fees of 1+%, to buy US stocks.

Tax is a bit more involved. The tax-efficient corporate structure, which turns US dividends, normally ordinary income, into cap gains instead for Canadian taxes is good in taxable accounts but then the tax credit on the 15% withholding taxes paid on US dividends is lost (e.g. 15% of 4% div = 0.6% lost). If your ord income tax rate is 40%, you would pay 40% x 4% div = 1.6%, while the cap gains rate would be half = 0.8%, plus the lost withholding tax of 0.6% would total 1.4%. PDF would thus be a little bit better tax-wise than holding US stocks or US ETFs of US stocks in a taxable account.

see also previous posts and

Maybe it's time for a post looking at US dividend ETF alternatives!

Anonymous said...

Not sure how you end up picking CDZ. If you look into the methodology you'll find it picks stocks basically for yield and ends up stocks like AGF being the top position. Performance wise it has lagged - 8.1% over the past year ending Jan 2014 where the group average was over 11%. The only ETF with solid performance that didn't achieve it by being heavily weighted toward financials was DXM.

CanadianInvestor said...

Anon, re CDZ the reason I found it attractive relates to the wide spread among sectors, the low overall concentration in any one stocks, the apparent quality of holdings (few stocks with ultra-high yields / payout ratios / dividends greater than earnings and of course no dividend cuts). Yes the 1 yr performance lags the others and the XIU benchmark but we cannot expect it always to outperform. The 5yr performance number looks solid. btw, CDZ weights for yield but picks stocks for dividend increases. AGF is held by four other dividend ETFs (XDV, ZDV, XEI, VDY) but it has not increased its dividend for 2 years so it is at the boundary of CDZ's maximum two years without an increase rule - it may soon be dropped.