ETFs and the Dividend Dilemma

 |  Includes: BPT, CPL, GLDX, SPY, URA
by: Roger Nusbaum

GlobalX is about to launch the GlobalX Gold Explorers ETF (NYSEARCA:GLDX) and the GlobalX Uranium ETF (NYSEARCA:URA) as soon as today--I received an email yesterday saying it would be today but occasionally these things get pushed back but either way they are coming imminently.

In looking under the hood they are both very narrow exposures within the materials sector. GLDX appears to own micro cap stocks, I only recognized three names in the top ten and URA looks a lot like the GlobalX Lithium ETF (NYSEARCA:LIT), another narrow exposure in the materials sector, in that it has one stock at 20% of the fund, that being Cameco (NYSE:CCJ) with a couple more names at about 12% of the fund.

Generally I think the narrow specialization is a great thing for those who wish to take advantage of it. A long time ago GlobalX filed for these funds and has been bringing them to market and there are quite a few left to possibly come from the filing I'm referring to. Because of some immediately popular funds they seem to give their funds a decent shot at working out.

One thing that very narrow funds can do is to reduce the need for using individual stocks allowing individuals who are comfortable with industry selection but not stock selection to incorporate some very specific attributes into their portfolio. That is all good but there is still a potential drawback that I see which is dividends.

URA will very likely always correlate closely to Cameco but the stock pays a small dividend of 0.90%. I doubt that URA will have a dividend. If the two do correlate as closely as I would expect then the extra 90 basis points could matter in terms of thinking about the yield of the entire portfolio. Given that most years the market is up a little or down a little and that it, the S&P 500, has been yielding close to 2% for a long time now, a lot of value can be added by structuring the portfolio to yield 3-3.5%, if you can get more and still be properly diversified that is great.

Getting 3-3.5% of dividend yield from a narrow based portfolio that relies heavily on ETFs is not easy to do. When you take into account that many narrow based ETFs charge a fee of 50-75 basis points that usually comes out of whatever dividends it might collect you can see that getting a big yield from an ETF portfolio is in fact difficult.

I agree with the various dividend zealots that having a yield greater than the market is important but not at the exclusion of a properly diversified portfolio; I would say a portfolio of very high yielding domestic mega caps stocks is not well diversified but I realize others disagree.

The answer here is going to involve at least some exposure to individual stocks. Doing a little simple math, putting 20% of a diversified equity portfolio into a handful of names that yield 7% and assuming the other 80% is in ETFs and can get 2%, that adds up to a yield of 3%. A couple of names that could fit the bill include BP Prudhoe Bay Royalty Trust (NYSE:BPT) which yields 7.7% and CPFL Energia (NYSE:CPL) which is a Brazilian utility and of course there are others each with their own risks. As an FYI I have never owned either name so this is not a recommendation.

As a more practical approach for people willing to own a few more individual stocks with their ETFs there are plenty of medium to low beta stocks that yield 4-5%, even 6% and while this is more work it can lift the overall yield pretty effectively without having a lot of single stock exposure.

One update: a few weeks back I mentioned Schwab making pinksheet foreign ordinaries available for web trade "soon." Well Schwab has done this for 23 markets and while the rep I spoke to was not aware of a list of these countries online he said it was most of the bigger markets ex-Latin America. To be clear this is pinksheet trading of foreign stocks not trading directly on foreign markets. This is progress but many of these stocks are not very liquid on the pinks. My hope is that Schwab will get it together for direct access as several competitors have already done.

The picture is from the new Adidas commercials with the guy from The Hangover that I think are hysterical. You can click on the picture to see the video if you've not seen the commercial on TV.