5 ETFs for the Dividend Investor

If you’re looking to build a portfolio around companies that pay dividends, you’ll find a treasure trove of choices in exchange-traded funds. At least 35 ETFs follow a dividend-focused strategy, investing in income-paying stocks of large companies and small ones, in U.S. corporations as well as firms based overseas. And that doesn’t include the ETFs that invest in real estate investment trusts and master limited partnerships, two groups that tend to offer high yields.

It’s no surprise that dividends have returned to their rightful place as a key building block in investor portfolios. Historically, dividends have accounted for more than 40% of the stock market’s returns. They represent real cash in your pocket now. And after watching their paper profits go up in flames twice during the past decade’s two bear markets, burned investors realize that dividends are the only sure profits they can count on from stocks.

More than that, dividend-paying companies are among the most stable and least volatile companies on the market. The constant need to pay cash means these companies are consistently profitable and have management teams capable of keeping them that way.

Yield — a stock’s annual dividend rate per share divided by its share price — is always an important consideration when building a dividend-based portfolio. SPDR S&P 500 (SPY), an ETF better known as the Spider, tracks Standard & Poor’s 500-stock index; as of December, the ETF yielded 1.8%. SPDR Dow Jones Industrial Average ETF (DIA), formerly called the Diamonds, yielded 2.5%. If you can get yields of this amount from the key market benchmarks, you should eliminate any fund that pays less.

One of the best strategies is to invest in companies that increase their dividends on a regular basis. Firms that boost their payouts regularly are almost always those that generate steadily rising profits and are run by managers who are confident about the future.

Our top choice is SPDR S&P Dividend ETF (SDY), which tracks the S&P High-Yield Dividend Aristocrats Index. It holds 60 companies from the S&P 1500 Index that have lifted their dividends at least 25 straight years. Most are high-quality, large-capitalization stocks that trade at reasonable prices.

Over the past five years, SDY returned 3.3% annualized, beating the S&P 500 by an average of one percentage point per year. In 2010, the ETF returned 16.4%, compared with the S&P’s 15.1% rise. SDY’s annual expense ratio is 0.35%. (All returns are through December 31.)

For the full write up on the other five ETFs, WisdomTree Emerging Markets Equity Income Fund (DEM), First Trust DJ Global Select Dividend Index Fund (FGD), iShares S&P U.S. Preferred Stock Index Fund (PFF), Guggenheim Multi-Asset Income ETF (CVY) go to Kiplinger.com to read 5 ETFs for the Dividend Investors.

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Net Cash Inflows Double; Large-Caps Lose, Emerging Markets Win

Net cash inflows into all exchange-traded funds (ETF) and exchange-traded notes (ETN) grew to approximately $17.1 billion in May, doubling April’s total, according to the National Stock Exchange (NSX). Despite the huge inflow overall, ETFs holding large-capitalization indexes such as the S&P 500, Dow Jones Industrial Average and the Russell 1000 posted significant cash outflows. Meanwhile, emerging-market ETFs recorded huge net inflows.

iShares remained the top ETF firm with $290 billion in assets under management. State Street Global Advisors came in second with half that, $142 billion. Vanguard took third at $54 billion. PowerShares’ $31 billion came in fourth and ProShares $26 billion claimed fifth.

The SPDR Trust (SPY) remained the king with $63 billion in assets. SPDR Gold Shares (GLD) came in second with a distant $35 billion.

I noticed a trend of heavy net cash outflows from the large-cap U.S. equity funds. So, even as the market rose in May, the SPDR saw $146 million flow out in May. The PowerShares QQQ (QQQQ), which tracks the Nasdaq 100 and is the sixth-largest ETF, had outflows of $435 million. Meanwhile, $639 million was pulled out of the Dow Diamonds (DIA), which tracks the Dow industrials. Surprisingly, the iShares S&P 500, (IVV) which also tracks the S&P 500 and is the fifth-largest ETF, saw net cash inflows of $441 million. However, all the iShares ETFs that track the Russell 1000 or an offshoot also saw outflows. Does this mean that traders think the U.S. stock market has peaked and have taken profits? I wouldn’t be surprised.

That money appears to be moving into emerging markets. The iShares MSCO-Emerging Markets (EEM) took honors as the third-largest ETF upon receipt of $1 billion in cash inflows in May. The only ETF with more net inflows was the iShares MSCI Brazil (EWZ) with $1.5 billion.

Year-to-date net cash inflows totaled approximately $29.8 billion, led by fixed income, commodity, and short U.S. equity based ETF products, says the NSX. Assets in U.S. listed ETF/ETNs grew 10% sequentially to approximately $594.3 billion at the end of May. The number of listed products totaled 829, compared with 767 listed products a year ago. This data and more can be found in the NSX May 2009 Month-End ETF/ETN Data Report.

Dow Kicks Out GM; S&P Still Holds It

Former GM CEO Rick Wagoner upon realizing what just hit the fan.

4 pm.

Late night I sent my story about General Motors and the indexes out to a few people, including some people at Dow Jones. This morning General Motors is pulled from the Dow Jones Industrial Average. Coincidence? I’ll let you decide.

Today, Dow Jones pulls GM and Citigroup out of the DJIA. The two companies will leave June 8 to give index fund investors time to adapt to the deletion and addition of two new components, Cisco Systems and Travelers. Since GM is getting knocked off the New York Stock Exchange tomorrow, GM will be going to an over-the-counter market, representatives for Dow Jones Indexes said they will use “the best available price source” for the next week. Can you imagine, the Dow being priced off the Pink Sheets. That’s the true Wild West of Wall Street. Oh, the humanity!

Since the DJIA is created by the editors of the Wall Street Journal, there’s no requirement for them to remove GM before today.

One thing to remember is that an index isn’t a portfolio. A fund or ETF is a portfolio. It lives in the real world and costs money to maintain. An index is just a construct that measures the market.

A Dow component since 1925, GM has been a significant part of measuring the stock market through the 1920s bubble, the crash of 1929, the Depression and every up and down of the American economy since. It’s only fitting that the index itself should suffer and be brought down by this once mighty component. If the index is the market and GM has been a huge part of the market and the American economy for so long, it’s appropriate that the Dow should hold it until today to give a proper measurement of the U.S. stock market and economy. But, that’s not good for funds that follow the Dow, such as the Dow Diamonds (DIA). They will probably suffer the loss even though they would have liked to get rid of the stock months ago.

However, the S&P 500 is rules based and a company needs to have $3 billion of market capitalization to remain in this “Large-cap index.” GM hasn’t had $3 billion since December. At the close on Monday, it was still in the index.

Here’s a great video from The New York Times: The Decline of G.M..

Meanwhile back at the other automobile bankruptcy in America, it appears Tommy Lasorda has been brought in as Chrysler’s vice chairman to make the Chrysler bankruptcy work. I wonder if they will bring in Joe Torre to fix GM.

Making the Case for Index Funds

Investing is long term. Speculation is short term.

Can you watch the market every day? If not, you should invest, rather than speculate. Without a doubt indexing is the way to invest. The crash of 2008 has not only highlighted the risk of owning single stocks, but also exposed the dirty underbelly of actively managed mutual funds.

Going for the index avoids getting stuck with the stocks that might be left behind. If you believe in the concept of diversification, then single stock risk is just too huge of a risk to take. And while you might be able to buy 20 stocks and build out a nice portfolio, one bad stock can wipe out 5% of your portfolio and two bad stocks decimate the fund. (Get it? Decimate? Remove 10%. Ok, moving on. …)

If you want to own financials, 30 are better than two stocks. If the two financials you owned last year were Bear Stearns and Lehman Brothers, you, my friend, have completely lost your portfolio of financials, and maybe your entire portfolio. Buying an index fund tracking the financial sector of the S&P 500, such as the Financial Select Sector SPDR (XLF), gives you 80 stocks, about 11% of the S&P 500. You can get more exposure to one narrow niche of the market and diversification at the same time, hence less risky. Sure, the financials took a hit, but considering most of them are still in business, you still have some of your investment.

So, single stock risk is out if you’re not buying for dividends. But what about actively managed mutual funds? The whole point of the actively managed fund is to give you, the investor, alpha, those extra percentage points of return that comes from the fund manager’s skill and intellect. The financial crisis has shown how hard it is to find true alpha.

It’s pretty much common knowledge these days that only about 20% of active fund managers beat the major market benchmarks. Considering many active funds are essentially index fund copycats, you will never beat the market with their huge management fees. Fund managers counter that even if they don’t beat the market going up, they at least have the ability to post narrower losses on the way down, because they can sell off the worst performing sectors while the index can’t. I think a little bit of research will show they are also posting returns worse that the indexes on the loss side as well.

And even those that don’t post worse losses, is a 35% loss that much of an improvement over a 37% loss?

So, if you eliminate single stock purchases and actively managed funds, deductive reasoning says you must go with the index. Of course, this mostly applies to U.S. equities. In some markets, such as emerging markets, a smart manager might have some market knowledge that hasn’t disseminated widely, but in the U.S. that kind of information gets spread around pretty quickly.

Indexes can be volatile and risky. If the stock market falls, an index tracking the stock market will fall. However, with the index fund you can rest in the knowledge you matched the market and didn’t do worse than most of the market.

If you really want a lesson, John Bogle, the inventor of the index mutual fund, explains why indexing is better than stock picking in “The Little Book of Common Sense Investing.” Essentially, Bogle says you can maximize returns and lower risk by not buying single stocks but mutual funds. Followers of Bogle have written a book called “BogleHeads” which expands on this theme.

Now in a shameless plug for myself, my book ETFs for the Long Run takes Bogle’s argument one step further. I agree with Bogle that indexing is the way to invest. Bogle likes the mutual fund structure, but I think Exchange Traded Funds are the mutual fund for the 21st century. In the book, I explain indexing, the advantages of buying mutual funds instead of single stocks and then why ETFs are better than mutual funds. The key reasons being they are cheaper, more tax efficient, more transparent and more flexible. I also explain how to buy and sell ETFs and how to use them to build a portfolio.

Since you don’t know what sector of the market will rise, you should own a broad market index, such as the Vanguard 500 mutual fund, (VFINX), or buy an ETF such as the SPDR, (SPY), or the iShares S&P 500 Index (IVV). The Diamonds Trust (DIA) tracks the Dow Jones Industrial Average and the PowerShares QQQ (QQQQ) follows the technology heavy Nasdaq 100 index. The Vanguard Total Bond Market (BND) is a broad bond index.

Then you break it down into sector specific indexes that you want to follow.

Finally, you need to watch fees. ETFs typically charge smaller expense ratios than mutual funds. However, if you are dollar cost averaging, which in this market is the only way to go, the ETF’s commission will significantly eat into your returns if you invest less than $1,000 a pop. If you are investing less than $1,000 a pop, then go with a no-load index fund. Buying an index fund with a load is like paying for your own security in a gated community. It’s a waste of money.

Qubes Celebrate 10th Birthday

The Qubes, one of the most famous ETFs in the world, celebrated its 10-year anniversary yesterday.

The PowerShares QQQ (QQQQ), formerly known as the Nasdaq 100 Index Tracking Stock, hit the market March 10, 1999, in what remains the biggest most successful launch of a single U.S. ETF. Today, it is one of the most actively traded securities in the world.

“It is the most traded security in shares and dollar volume over the last ten years,” says John Jacobs, executive vice president of NASDAQ OMX Global Index Group and the man who created the fund.

While it currently trades on the NASDAQ Stock Market, originally it launched on the American Stock Exchange with the ticker symbol QQQ. This gave the ETF, then called a tracking stock, the nicknames of the “QQQ”, the “Triple Q” and the “Qubes.”

Launched at the height of the Internet stock market bubble, the Qubes fed the investing public’s desire for an easy to trade instrument that held the fastest growing stocks in the world. The NASDAQ 100 index holds the 100 largest non-financial stocks listed on the NASDAQ. That’s a lot of technology, biotechnology and retail.

It’s first day, it traded 2.6 million shares, 53 percent more than the record set two years earlier by the DIAmond Trust (DIA), the first ETF to track the Dow Jones Industrial Average. After just two hours, the NASDAQ 100 ETF, blew away the DIAmond’s first-day total volume of 1.7 shares. Within two weeks, it had traded 30 million shares. At the end of 2000, the Qubes held more than $6 billion in assets. A little more than two months later, on its first anniversary, the Qubes held more than $12 billion.

For a while, it surpassed the assets and daily volume of the first ETF, the Standard & Poor’s Depositary Receipts, or SPDR Trust, (SPY). Yesterday, it held $10.26 billion in assets.

“The Qubes stellar rise signaled to Wall Street that exchange-traded funds were not just a one-hit wonder. It showed potential sponsors there was a market for these products if the index was right.” (For more on the birth of the Qubes, the history of the ETF industry, and why the NYSE refused to let this ETF use the single “Q” ticker symbol, grab a copy of ETFs for the Long Run.) A little more than a year later, Barclays Global Investors launched its iShares family of ETFs. By the end of 2000, there would be 55 iShares.

Ironically, on the Qubes’ first anniversary, March 10, 2000, the NASDAQ Composite Index, which tracks every stock on the NASDAQ, hit its all-time high of 5048.62. The Qubes posted a 12-month return of 125%. The next trading session, the Internet bubble popped, sending the entire stock market into a two-year decline.

On the tenth anniversary, the Nasdaq soared 89.64 points, or 7.1%, to 1358.28, and the ETF jumped $1.59, or 6.2% to $27.33 on volume of 175 million shares. Did the excitement over the Qubes anniversary spark a huge rally in the market? Don’t laugh so quickly. Currently, the NASDAQ-100 Index is the basis for more than 900 products in 34 countries with about $490 billion dollars in notional value tied to it. To date, the index has traded more than 600 million futures contracts with a notional value of more than $25 trillion. Options experts SchaeffersResearch.com says the Qubes saw call buying activity early yesterday.

Of course, Citigroup (C), one of the country’s largest banks, did raise its head from its deathbed to say it was doing very well the first two months of the year, sparking a huge rally in the financial sector. The Dow Jones Industrial Averaged surged 5.8% to 6926 and the S&P 500 leapt 6.4% to 720.

Invesco PowerShares bought the NASDAQ’s ETF business in 2006. It changed the name of the ETF to the PowerShares QQQ in honor of what most people called the fund. However, the ticker has changed to QQQQ because it trades on the NASDAQ Stock Market, which uses four letters in its tickers. The NASDAQ says its market share of U.S. ETFs is more than any other U.S. exchange. In January 2009, volume grew 22% year-over-year to 655 million shares.

The NASDAQ OMX Global Index Group, a unit of the NASDAQ’s parent company, the NASDAQ OMX Group, remains a global leader in creating and licensing strategy indexes. Its most recent being the Government Relief Index and the European Government Relief Index, which include companies currently being bailed out by their governments.

World Map of Financial Turmoil

For people who want their bad news in one large dose vs. many small doses, the Global Indices Map is like a world map of financial turmoil. This constantly updated global map from Google lists almost all the major stock market indices around the world and gives a feel for how the world markets are doing at any point in time. It’s a cool idea.

However, I already noticed the map is missing the S&P 500 index, which is considered by most market participants to be the true benchmark of the U.S. market.

On needs only to look at where investors are putting their money. The SPDR (SPY), the largest ETF in the world with $83.8 billion in assets, tracks the S&P 500, while the Dow Diamonds (DIA), which tracks the Dow Jones Industrial Average, holds only $7.76 billion.

ETFs See Cash Inflows Even as Asset Values Fall

ETFs and ETNs continue to see net cash inflows even as total assets under management fall. The conclusion is this is a function of just falling asset values.

According to the National Stock Exchange (NSX), at the end of November, total U.S. listed ETF and ETN assets fell 16.8% to $487.6 billion from $585.8 billion in November 2007. However, net cash inflows for the month were $26.4 billion, bringing the total net cash flow for the 11 months through Nov. 30 to $136.8 billion. In November, 315 ETFs saw net cash inflows, while 179 saw outflows. ETNs split at 16 each.

Notional trading volume in both ETFs and ETNs fell 33% in November from October to $2.2 trillion. Surprisingly, this represents a record 43% of all U.S. equity trading volume, up from 38% in October. That just shows how much total equity volume must have fallen off. At the end of November 2008, the number of listed products totaled 843, compared with 650 listed products one year ago and 806 in October.
According to the NSX, the only ETF firms that saw assets grow are State Street Global Advisers, ProShares, Van Eck and

Ameristock/Victoria Bay. All those firms saw net cash inflows for the year through Nov. 30 increase compared with the first 11 months of 2007. Vanguard did as well. ProShares’s assets under management rocketed 112% to $20.9 billion. SSGA’s assets grew 8.3% to $142.9 billion. This really shouldn’t be a surprise. ProShares sponsors the inverse and leveraged ETFs that have proved hugely popular in the market turmoil. SSGA sells the largest, most liquid ETF, the SPDR (SPY), which tracks the S&P 500. Many investors making a flight to safety or seeking a place to hold cash on a temporary basis will move to the S&P 500. Even as the S&P 500 sinks, the SPDR’s 2008 net cash inflows have surged 86% year-over-year through Nov. 30 to $18.23 billion.

Meanwhile, BGI’s iShares saw assets tumbled 29% to $229.3 billion.

Firms with net cash outflows in November included PowerShares, $309 million, and Merrill Lynch’s HOLDRs, which saw redemptions of $889 million. Surprisingly, the HOLDRs saw net cash outflows of $3.6 billion in 2007, but are up $1.2 billion so far this year. Other firms that experienced outflows in November were WisdomTree, FirstTrust, and SPA-ETF. Firms with net outflows year-to-date include Bank of New York, Rydex, X-Shares, Ziegler, FocusShares and BearStearns. The last two have gone out of business this year. Rydex is suffering as the strengthening dollar hurts its CurrencyShares.

As for ETNs, Barclay’s iPath family saw assets plunge 36% to $2.6 billion. In November, iPath saw outflows of $39 million. Morgan Stanley/Van Eck ETNs recorded outflows of $16 million in November. Meanwhile, Goldman Sach’s ETNs net cash outflows grew to $97 million year-to-date. Comparisons are not relevant for many of the other ETN firms as they had few funds, if any, last year.

Among the top ten ETFs and ETNs, the SPDR (SPY), iShares MSCI EAFE Index Fund (EFA), SPDR Equity Gold (GLD), iShares S&P 500 Index Fund (IVV), iShares Russell 1000 Growth Index Fund (IWF) and iShares Russell 2000 Index Fund (IWM) all saw net cash inflows in November, according the NSX. Of the 10 largest funds, these saw outflows last month: iShares MSCI Emerging Markets Index Fund (EEM), PowerShares QQQ (QQQQ), iShares Barclays Aggregate Bond Fund (AGG) and the Dow Diamonds (DIA).

The NYSE Group also releases volume data for its exchanges. Average daily matched volume for ETFs, or the total number of shares of ETFs executed on the entire NYSE Group’s exchanges surged 93.5% to 672 million shares from 347 million shares in November 2007. Total matched volume for the month totaled 12,765 million shares, a 75.1% increase. Total volume year-to-date through Nov. 30 jumped 74.7% from the same period last year to 102,583 million shares.

Handled volume, which represents the total number of shares of equity securities and ETFs internally matched on the NYSE Group’s exchanges or routed to and executed at an external market center, totaled 14,813 million shares last month, a 77.6% surge over the year-ago month. Average daily handled volume rocketed 96.3% to 780 million shares from 397 million shares a year ago. Year-to-date total volume climbed 78.1% to 117,629 million shares.

The NYSE also reported total ETF consolidated volume for the month leapt 92.1% to 45,151 million shares, while total average daily volume soared 112.3% to 2,376 million shares. Year-to-date, total consolidated ETF volume surged 119.4% over the first 11 months of 2007 to 355,133 million shares. I think those refer just to the NYSE Group.

How Did ETFs Fare in Market Turmoil

 

With cries of financial Armageddon and headlines screaming “heaven help us,” it shouldn’t have surprised anyone that the stock market took a head dive today.  The refusal of the House of Representatives to pass the $700 billion Wall Street bailout sent shivers through Wall Street. Everyone realizing the golden days are over made a mad dash for the exits.

 

“The first problem is the administration gave it the wrong name,” says Jerry Slusiewicz, president of Pacific Financial Planners of Newport Beach, Calif. “They should have called it the ‘economic stabilization plan’ or ‘liquidation enhancement plan,” instead they called it a ‘bailout’ and that was bad news. No one wants to bail out Wall Street.”

 

So, how did exchange-traded funds hold up amid the market turmoil?

 

“The ETFs followed the market,” says Kevin Mahn, chief investment officer of SmartGrowth Mutual Funds, which runs funds of ETFs. “The SPDR Gold Shares (GLD) was up as well as a lot of the short products from ProShares.” 

 

The truth of the matter is the ETF is only as good as the assets it’s holding. And if your ETF tracks the Dow Jones Industrial Average the day it plunges 777 points, like it did Monday in the largest one-day decline in history, you’re going to feel some pain, $6.40, or 5.76%, to be exact. Surprisingly, the Diamonds Trust, the ETF which holds every stock in the Dow, actually performed better than the index itself, which sank 6.98%. Who knew tracking error could work in your favor?

 

The same thing happened with the SPDR (SPY), the most heavily traded ETF on the market today, with 460 million shares trading hands. While its tracking index, the S&P 500 plummeted 8.79%, the SPDR tumbled just 7.84%, or $9.47.

 

The iShares S&P 500 Value Index Fund (IVE) beat the broader benchmark, and the growth sector, falling 6.76% to $57.85, on volume of 3.6 million shares, while the iShares S&P 500 Growth Index Fund (IVW) also beat it, sliding 7.1% to $54.66. And both closed at a premium to their net asset value, which was $56.34 for the value fund and $53.93 for growth, according to iShares.

 

And what of the fundamentally-focused ETFs which claim to do better than market-cap ETFs? How did they perform? PowerShares FTSE RAFI 1000 Portfolio (PRF) narrowly beat the S&P 500, with a decline of 7.46% to $44.02 on volume of 251,884 shares. The WisdomTree LargeCap Dividend Fund (DLN) slid 6.4% to $45.13 on 38,000 shares and the Spa MarketGrader LargeCap 100 (SZG) dropped just 5.34% to $17.55, with only 400 shares traded. All the fundamental ETFs also closed significantly higher than their NAVs.

 

“The House vote was basically a vote of no confidence for the credit markets,” says Slusiewicz. “Credit is drying up for short-term cash for the economy. We’ve backed ourselves into a corner.”

 

Overall the flight to quality led to an interesting divergence in the bond ETFs.

 

“The 0.4% move in the BIL was a hefty move,” says Jim Porter, the portfolio manager of Aston/New Century Absolute Return ETF Fund (ANENX).  “It broke out four days ago as there was definitely a sign of movement into the T-Bill ETFs. Meanwhile the Vanguard Intermediate Term Bond was actually down today. It’s obvious that no one wants to own the Intermediates. But the T-Bills and the long bonds are OK.”

 

n      The SPDR Lehman 1-3 Month T-Bill ETF (BIL) gained 20 cents, or 0.43%, to $46.24. This sent the yield down to 1.46% from 2.73% on Aug. 31.

 

n      The iShares Lehman 1-3 year Treasury Bond ETF (SHY) edged up 0.6% to $83.89, yielding 3.69%, up from 3.48% on Aug. 31.

 

n      The iShares Lehman 20+ year Treasury Bond ETF (TLT) climbed 2.9% to yield 4.68%, up from 4.53% on Aug. 31.

 

n      Meanwhile the Vanguard Intermediate Term Bond (BIV) fell 31 cents, or 0.42%, to 74.37. Since Aug. 31, when it yielded 4.63%, the BIV’s yield has plunged to a negative 1.64%.

 

So, what can we expect for the rest of the week? With the Jewish New Year occurring Tuesday and Wednesday, Congress won’t tackle any business until Thursday. In addition, with many market participants out, volume will probably be low, but that could create large price moves. The third quarter ends on Tuesday, so it should be an interesting day for mutual fund managers who need to shore up their portfolios for end-of-quarter reports.

 

“A lot of what we saw erased today will come back when the bill gets passed,” says SmartGrowth’s Mahn. “But there will be a lot of trepidation over the next few weeks to see if another bank fails and if this bailout works and how quickly it works.”   

 

Slusiewicz of Pacific Financial Planners thinks Congress will try to revive the deal because everyday that passes without one will see more market declines. He says the CBOE Volatility Index, or VIX, posting on Monday was “one of the top ten days for the fear index. The big fear number is an indication of a bottom. And the bottom will come with the passing of a new bailout bill.”

 

But, if there’s no bill Slusiewicz expects more days like Monday. With no bill, he predicts potential declines of 100 points on the S&P 500, 200 points on the NASDAQ and 700 points on the Dow.