Are ETFs and CEFs Good for Dividend Investing?

Dividend investing is not about buying high-yield stocks to generate a high income. Instead, dividend investing is all about finding solid dividend stocks that are reasonably priced and are expected to continue raising their dividends in the future. Most of the time their current yields aren’t eye-popping, but the growing divdends over time will more than compensate for the current yield. So, are Exchange Traded Funds (ETFs) and Closed Ended Funds (CEFs) a good fit for this strategy?

A couple of years ago, I started adding select ETFs and CEFs to my income portfolio. At the time, my thought process was that these funds would diversify my risk and add a degree of stability to my income portfolio. Initially, I had high hopes for their success. Here’s what I am holding and a synopsis of how they have performed:

Vanguard Financials ETF (VFH)

Vanguard Financials ETF seeks to track the performance of a benchmark index that measures the investment return of financial stocks.

I first purchased VFH in August 2007. Like the financials it tracks, VFH’s dividend has steadily fallen from $0.45/share in October 2007 to $0.06/share in March 2009.

PowerShares International Dividend Achievers Portfolio (PID)

PID seeks to match the performance of the International Dividend Achievers Index by investing at least 90% of its total assets in dividend paying common stocks of this index. This index tracks the performance of dividend paying American Depositary Receipts or ordinary stocks trading on the NYSE, NASDAQ or AMEX.

I initially invested in this fund back in July 2008. It has paid out three dividends since then, each less than the one before (9/08-$0.14/share, 12/08-$0.09/share and 3/09-$0.03/share). Not a good trend.

Vanguard REIT ETF (VNQ)

Vanguard REIT ETF seeks to provide a high level of income and moderate long-term capital appreciation by tracking the performance of a benchmark index that measures the performance of publicly traded equity REITs.

I initiated my VNQ position in August 2007. VNQ’s dividends have been unpredictable and inconsistent.

SPDR S&P Dividend ETF (SDY)

The Fund seeks to replicate as closely as possible, before expenses, the price and yield of the S&P High Yield Dividend Aristocrats Index. The Fund uses a passive management strategy designed to track the price and yield performance of the Dividend Index.

I first purchased SDY in August 2007. I have received seven dividends ranging between a low of $0.4410 (April 2009) to a high of $0.5917 (January 2009). I found it somewhat odd that the low and high dividends both came in 2009.

Vanguard High Dividend Yield ETF (VYM)

Vanguard High Dividend Yield ETF seeks to track the performance of a benchmark index that measures the investment return of common stocks of companies that are characterized by high dividend yields.

I first bought into VYM in August 2007. Its dividends have slowly drifted lower since that time. They have not been as volatile, but there is no question as to the direction.

Vanguard Dividend Appreciation ETF (VIG)

Vanguard Dividend Appreciation ETF seeks to track the performance of a benchmark index that measures the investment return of common stocks of companies that have a record of increasing dividends over time.

VIG is another ETF that I first purchased in August 2007. During the time I owned it, VIG’s dividend has fluctuated between $0.22/share and $0.28/share.

Eaton Vance Tax-Advantaged Global Dividend Opportunity (ETO)

ETO is a diversified, closed-end management investment company. The Fund’s investment objective is to provide a high level of after-tax total return. It invests primarily in dividend-paying common and preferred stocks.

I first purchased ETO in July 2008. ETO paid a steady dividend of $0.1795/share through December 2008. It then dropped its dividend to $0.1167/share.

Alpine Total Dynamic Dividend Fund (AOD)

AOD attempts to optimize both dividend income and long-term growth of capital. This is a very diverse and flexible fund. It employs a global, multi-cap, multi-sector, and multi-style investment approach. The fund combines four research-driven investment strategies – Growth, Value, Special Dividends, and Dividend Capture Rotation.

I first purchased AOD in December 2007. It paid monthly dividends of $0.18/share through February 2009 before cutting its monthly dividend to $0.12/share.

Vanguard Long-Term Bond ETF (BLV)

The Fund seeks to match the investment performance of the Lehman Brothers Mutual Fund Long Government/Corporate Index. Holdings include Corporate Notes/Bond 51.5%, Treasury Notes/Bonds 40.2% and Government Agency Securities 6.5%.

I first purchased BLV in December 2008. Since that time I have received five dividend all approximately $0.34/share. This has been the one bright spot among the group. As a long-bond fund, it has behaved as I expected it would.

Conclusion

Back to the original question: Are Exchange Traded Funds (ETFs) and Closed Ended Funds (CEFs) a good fit for this dividend investing? At this point, I would say no, for the most part. For many of the same reasons that international investments are not a good fit for a dividend-based investing strategy, I have found the same true with ETFs and CEFs.

It has been my experience that ETFs/CEFs dividends exhibit a higher degree of volatility than individual dividend stocks. Since most of the above funds are based on an index, they are forced to buy the bad stocks with the good stocks. This will inherently increase the volatility of the funds dividend payments. Those with international holdings are subject to currency conversion and a different dividend payout philosophy. In the income portion of my portfolio, I place a great deal of value on stability and consistency. ETFs and CEFs have a difficult time delivering either.

The funds are listed in ascending order from least desirable to most. I have already stopped purchasing the above funds, except BLV. I will now work on eliminating or minimizing my position in most of them, starting at the top of the list and working down.

Full Disclosure: Long VFH, PID, VNQ, SDY, VIG, VYM, ETO, AOD, BLV. See a list of all my income holdings here.

Comments

[searcher]

The results are as would be expected in a bear market and economic slowdown for any equity approach. Bonds: not so bad - Stocks: not so good.

2009 May 07 11:19 AM

[Stock Gambler]

Thanks for the summary since Dividends, with Growth, is a large part of my investing also. However, with the majority of these having been purchased in the 2nd half of 2007, approximately 1-1/2 yrs ago at the top of the market, it would be interesting to revisit this summary in another 1-1/2 years to see the performance of these funds from this point.

2009 May 07 01:01 PM

[Alan Young]

I'm sorry, but this article is not well-grounded.

First you say, correctly, that the dividend growth strategy is designed to work over the long term. Then you proceed to judge your dividend funds based on less than 2 years--all of which was during the worst bear market in decades. OF COURSE they went down! Everything did! If you "expected" that dividend funds would continue to function unperturbed, your expectations were unreasonable.

It's true that CEFs are volatile, have to be entered with caution, and will underperform the market under some circumstances. But if you had intelligently invested in CEFs after the 2008 crash, you would be outperforming the market.

Disclosure: No positions in any of the funds mentioned. Long ETG (13% yield) and FAV (19% yield).

2009 May 07 01:11 PM

[TCK]

In checking the suggested picks I find they they do not trade options so consequently can't be combined with a covered call strategy.

A minor point, but just my style.

I currently use a covered call strategy with XLP and XLI.

2009 May 08 06:09 AM

[Steve20423]

I'm curious about your due diligence when selecting these funds up front.
I don't disagree with your conclusion but it appears you were speculating on most of them to be something their not.
A simple look at their history of payments indicates they are inconsistent. You can't really beat the index of your goal is to emulate it. I think purchasing a CEF is a good alternative if they actively manage to achieve their goal. But then you need to purchase at a deep discount to the market. When so doing there is less downside(in theory). I am sure you could have better choices if the goals and management of the funds were more in line with your own goals. I would like to know where to find more detailed analysis of CEF's If anyone can offer some websites or newsletters I would be grateful.

2009 May 08 08:47 AM

[Joe Eqcome]

Dividends4Life

Thank you for you observations. I like many of the other respondents agree that dividend investing is more than picking stocks with high yields.

However, your observation that there is greater dividend volatility in both CEF and ETFs than individual stocks seems to be a tautology, i.e., true by definition.

RICs, such as CEFs and ETFs, are legally bound to distribute their income and capital gains on an annual basis. As a consequence, such entities, by their very nature, would have distributions that fluctuate with stock market and the CEF managers' decision to harvest their capital gains. Operating companies are under no such distribution requirement and the dividends as a percentage of net income has averaged 50% to 60%. This has provided operating companies much more flexibility maintaining dividends in times of economic stress.

Much of your investment period (the late ‘70s) has been disappointing for shareholders and was reflected in the distribution of the CEFs. So, I'm not surprised with your results.

Lastly, what you may want to focus on is the composition of the dividend. The key is to find CEFs that continue to pay consistent amounts from net investment income which is more of a recurring source of distribution.

Joe Eqcome

2009 May 08 01:09 PM

[Joe Eqcome]

Steve20423

I maintain a website that focuses on CEFs that's free to interested investors. Additionally, there is a page on the website with links to other CEF related investor information. joeeqcome.web.officeli...

I hope you find this helpful.

Joe Eqcome

On May 08 08:47 AM Steve20423 wrote:

> I'm curious about your due diligence when selecting these funds up
> front.
> I don't disagree with your conclusion but it appears you were speculating
> on most of them to be something their not.
> A simple look at their history of payments indicates they are inconsistent.
> You can't really beat the index of your goal is to emulate it. I
> think purchasing a CEF is a good alternative if they actively manage
> to achieve their goal. But then you need to purchase at a deep discount
> to the market. When so doing there is less downside(in theory). I
> am sure you could have better choices if the goals and management
> of the funds were more in line with your own goals. I would like
> to know where to find more detailed analysis of CEF's If anyone can
> offer some websites or newsletters I would be grateful.
>

2009 May 08 01:15 PM

[starvin sargent]

Hey Joe, Why BLV? Have you considered other CEF bond funds? Are their any that meet your criteria? For me something like FOF where there are so many funds bundled together to spread risk or HTR that uses leverage on a bond portfolio seem to have more potential. Also TYG that captures the divys from energy is good for that steady inflation protected return. Although with all CEF's deleveraging HF's will drive the share price very badly, just look at ETO or FOF for that! Finally please write up your allocation to these instuments and sell and buy rules, thansk for your work

2009 May 09 09:21 AM

[Joe Eqcome]

starvin sargent

Thanks for your comments.

My sector allocation is the product of the industry model I developed and is based on adjusted historical performance of fund types during different phases of the economic cycle. In late/early economic phases, the fixed income does well as typically interest rates decline. This is usually followed by a rotation through the equity fund types. Of course each cycle is different. During the current cycle, credit issues became a impediment to the fixed income fund types initial advance. This was particularly true of the preferred fund typds

As it relates to the CEF analytical process, the investment algorithm I use is order of importance is: 1) Consistent high returns on NAV; 2) Abnormally large discounts for NAV (price, historical average, fund or sector type); 3) fund type or sector momentum (relative strength); 4) reasonable and sustainable distribution policy (investment income as a percent of distribution); 5) reasonable expense ratio; 6) insider ownership; 7) asset size and trading liquidity. That is the criteria for the ratings.

I hope this is helpful.

Joe Eqcome



On May 09 09:21 AM starvin sargent wrote:

> Hey Joe, Why BLV? Have you considered other CEF bond funds? Are their
> any that meet your criteria? For me something like FOF where there
> are so many funds bundled together to spread risk or HTR that uses
> leverage on a bond portfolio seem to have more potential. Also TYG
> that captures the divys from energy is good for that steady inflation
> protected return. Although with all CEF's deleveraging HF's will
> drive the share price very badly, just look at ETO or FOF for that!
> Finally please write up your allocation to these instuments and sell
> and buy rules, thansk for your work

2009 May 11 01:49 PM

[bluballs]

CEF's are for dividend investing. Good doesn't come into the equation. I don't mean to be rude, but the whole premise behind your article is terrible. It's would be like asking, are medicines good for your health? Depending on your situation, some are and some aren't. Same thing goes for investing in dividends. Your answer that ETFs & CEFs are not good for dividend investing is a bad way to look at in my opinion.

2009 May 13 03:01 PM

[anarchist]

Even with the dividend cut to 0.12 AOD pays a hefty 21% yield.

2009 May 14 07:38 PM