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Income investors who purchase regionally-themed or industry-themed equity exchange-traded funds for dividend yield may be embracing risks they do not expect. The logic behind adding dividend-paying stocks from other countries to diversify an income portfolio is sound, but some fund holdings are hard to swallow.

The Allure of Using Themed ETFs for Income

Income investors who purchase dividend paying stocks hope to find steady income. A diversified mix of dividend-paying stocks, well-rated corporate bonds, and small allocations to alternative investments is a typical strategy to achieve this goal.

Most investors tend to over-invest in their domestic markets and can reduce risk by buying foreign stocks. Diversification across markets is a "free lunch" which, if done prudently, reduces uncertainty without lowering returns.

On the surface, themed ETFs appear to meet the needs of investors seeking dividend paying funds. These ETFs have familiar, easy to understand strategies like Belgian stocks or solar stocks and they have trailing dividend yields. Superficially, they are "no-brainers" for investors.

Check Under the Hood

Unfortunately, many of these funds have surprisingly large allocations to the real estate and financial sectors. Neither sector is a safe haven: financial companies are often highly leveraged and can report toxic assets at face values while real estate companies are often highly leveraged and are often subject to bubble pricing.

For example, property values in China, New Zealand and Australia are priced without regard to income, a symptom of real estate mania that many in the U.S. fell prey to five years ago. In short, investment fads can hit different countries at different times just like fads in music and fashion. Don't get caught in one.

A compilation of ETF sector concentrations from top dividend funds to uncover any surprises:

ETF

12-Mo. Yield

Financial Holdings

Real Estate Holdings

Market Vectors Uranium & Nuclear (NYSEARCA:NLR)

12.93%

0.00%

0%

PowerShares KBW Hi Div Yield Financial (NYSEARCA:KBWD)

13.04%

49.70%

47.98%

iShares MSCI Spain Index Fund (NYSEARCA:EWP)

9.68%

40.63%

0%

IQ Australia Small Cap ETF (NYSEARCA:KROO)

8.40%

3.60%

0%

SPDR S&P International Dividend (NYSEARCA:DWX)

6.15%

10.82%

3.90%

SPDR S&P International Telecom Sector (NYSEARCA:IST)

4.67%

0.00%

0%

WisdomTree Europe SmallCap Dividend (NYSEARCA:DFE)

5.94%

12.08%

3.63%

WisdomTree Australia Dividend (NYSEARCA:AUSE)

6.39%

19.81%

0.08%

iShares MSCI New Zealand Invstb Mkt Idx (NYSEARCA:ENZL)

6.54%

1.51%

12.01%

WisdomTree Middle East Dividend (NASDAQ:GULF)

5.61%

36.04%

2.57%

First Trust STOXX Euro Select Div Idx (NYSEARCA:FDD)

5.69%

38.88%

3.35%

iShares MSCI Poland Investable Mkt Index (NYSEARCA:EPOL)

5.72%

41.25%

1.12%

iShares Dow Jones Intl Select Div Idx (NYSEARCA:IDV)

5.48%

18.63%

1.61%

WisdomTree DEFA Equity Income (NYSEARCA:DTH)

5.11%

26.42%

0.73%

iShares MSCI Belgium Investable Mkt Idx (NYSEARCA:EWK)

5.13%

6.74%

0.64%

Guggenheim Multi-Asset Income (NYSEARCA:CVY)

5.42%

5.08%

12.78%

SPDR S&P 500 (SPY)

2.05%

12.43%

1.83%

Data compiled from Morningstar.com

Many of these ETFs do not have surprising real estate or financial sector allocations. For example, the Market Vectors Uranium & Nuclear fund does not have any substantial financial or real estate allocations, which is not surprising. Based on the name, investors would have guessed that it does not. The PowerShares KBW Hi Div Yield Financial fund's holdings are also consistent with its name and theme: It mostly invests in financial and real estate companies, as one would expect.

However, many of these ETFs have surprising sector allocations. For example, the iShares Dow Jones Intl Select Div Idx concentrates financial sector holdings above and beyond the 12.43% present in S&P500 index funds. A higher concentration in financials is probably not what income investors were hoping for when they purchased this fund.

Many foreign-themed ETFs have troubling allocations. There is a 40.63% allocation to financials in the iShares MSCI Spain Index Fund which might make this a vehicle for playing a eurozone rebound, but not an appropriate vehicle for steady dividend income. AUSE, GULF, FDD and EPOL all have higher concentrations in financials than the S&P 500. ENZL has a high allocation to real estate. High real estate and financial sector allocations may surprise many safety-seeking dividend investors.

Fortunately, several of the funds on this list provide dividend income with less real estate and financial exposure than the S&P 500. NLR, KROO, DWX, IST, DFE and EWK are candidates for prudent, international diversification of an income portfolio.

Clearly, investors should check under the hood when considering ETFs for their income portfolios.

Disclaimer: This article was written to provide investor information and education, and should not be construed as a guarantee or investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are. Please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing. Moreover, this research does NOT constitute a guarantee.

Source: Global Dividend ETFs: Diversification Or More Of The Same?