Inflation protection with High Dividend ETFs

Posted on: January 21, 2010 in: Uncategorized with 0 comments

If you’re holding bonds or bond ETFs, you may have noticed a faint light at the very end of the tunnel. I’m not sure how far or how fast it’s moving or when it will get here. All I can tell you is that it is Bank of Canada governor Mark Carney’s limo and he’s heading straight for you.

As the Globe’s Rob Carrick recently pointed out, one day, Mr. Carney will raise interest rates and send bond prices for a tumble.

If you’re holding individual bonds and plan to hold them to maturity, no worries. But if you’re holding Bond ETFs such as iShares XBB (mid-term maturities) or XSB (short-term maturities), then the prices of these ETFs will fall when rates go up. (Bond ETFs can’t ignore daily mark-to-market like an individual Bond can, as Mr. Carrick explains in his article.)

So – what’s the answer? You could choose XSB over XBB – with its shorter time to maturity, it should fall less than XBB.

Or you could buy high dividend paying Equity ETFs. Of course, you would take on equity risk but there are two scenarios to consider:

First, Mr. Carney will only raise rates if the economy is doing well and if the economy is doing well, then equities will be doing well too;

Second, if between now and the rate increase, the economy slows down, then the Equity ETF will fall in price but the high dividends will provide a cushion until the economy eventually recovers.

There are two Canadian equity high dividend ETFs to consider:

One is the iShares Canadian Dividend ETF (Ticker XDV) with a current yield of about 3.90%. It holds 30 companies and is 60% weighted to financials. Its biggest holdings include the five big banks. The MER is 0.50% or about $50 a year on a $10,000 investment.

The other is the Claymore TSX Dividend ETF (Ticker CDZ) with a current yield of about 4.70%. It holds 70 companies and is about 35% weight to financials and another 20% in energy companies. Unlike XDV, its top ten holdings don’t include any of the big banks. The MER is 0.60% a year.
As you can see, CDZ offers 0.80% more than XDV. If you add in the higher MER, it still works out to a 0.70% advantage for CDZ. This is because of how the two ETFs choose their holdings.

iShares’ XDV is based on a Dow Jones index that aims to represent at least 95% of the total Canadian market cap. As a result, it ends up buying the biggest companies that also pay a dividend. In other words, banks and insurers. Also, to be included in the Index, companies must have paid and increased thier dividends over each of the last five years.

Claymore’s CDZ is based on a S&P/TSX index that does away with the 95% of market cap rule. Instead, it looks for TSX-listed companies that have at least $300 mln in market cap and have paid and increased their dividends over each of the last five years. This means it has many smaller companies that pay higher dividends than the RBCs and Manulifes of the market.

Which one do I like more? The yield on the CDZ is tempting. It is also more diversified but across smaller, riskier companies. The blue-chip XDV charges a big safety premium. The choice really depends on how far down that tunnel you think Mr. Carney is and how long it will take him to get here.

As always, your comments are welcome.
Until next time,
Kind regards,
21 January 2010

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