The Dark Side Of Payout ETFs

August 28, 2012

When it comes to dividend ETFs, look before you leap.

Dividend-focused ETFs are tempting when you hold them up against the insanely low yields on benchmark U.S. government debt. But that doesn’t mean dividend ETFs are a good idea.

They might not even be a better idea than buying, say, a 10-year U.S. Treasury bond.

But first, some of the reasons why Treasurys currently look like such a bad idea …

Ten-year U.S. Treasury notes are at historical lows. Just look at debt slated to mature in 2022, which are yielding a positively wimpy 1.65 percent. I don’t know that I’d lend money to the federal government for such a skimpy return.

And that explains why ETFs promising dividend yields are all the rage.

Take the iShares High Dividend Equity Fund (NYSEArca: HDV), which launched March 29 of last year, and currently has more than $2 billion in assets, making it one of 2011’s most successful ETF launches. With a yield of 4.13 percent, that isn’t too surprising.

But HDV is just the tip of the dividend-crazed iceberg, with ETF sponsors marketing such funds to steer investors away from the currently not-so-tempting Treasurys market.

FlexShares recently filed paperwork laying out plans for no less than six dividend ETFs—three focusing on the U.S., the other three global in focus. Each trio is distinguished in terms of volatility, an investment strategy that might as well scream, “Volatility kills dividend yield!” I wish them well, but really?

There’s no denying dividend ETFs are sporting some mouth-watering yields—at least compared to Treasurys. For example, the PowerShares High Yield Equity Dividend Achievers fund (NYSEArca: PEY) is yielding 4.88 percent, the highest in its segment, according to IndexUniverse’s ETF analytics tool.

So why would I give my money to the U.S. government, when ETFs like PEY can get me three times the yield?


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