Your ETF Has ‘DRIP Drag’!

October 21, 2014

DRIP Cost Example

Let’s look at the costs of reinvesting IST’s latest distribution, versus what the costs would have been for a hypothetical mutual fund version of the S&P International Telecommunications index.

IST went ex-dividend on Sept. 19. Its closing NAV that day was 26.45. On the Oct. 1 payment date, IST opened 3.74 percent lower, at 25.57. In this case, time was on IST investors’ side, but that’s the exception, not the rule. Over the past three years, IST gained an average of 0.50 percent between its ex-date and its payable date.

Next issue is spreads. IST has traded at a median spread of 0.19 percent in the year through Oct. 13, 2014. Since we’re analyzing an ETF purchase, rather than a round trip, we should count only half this spread—0.095 percent—as a DRIP cost.

Overall, for the past few years, reinvesting IST’s dividends has cost 0.595 percent versus what you would pay for a mutual fund tracking the same index. IST’s distribution yield has been 13.69 percent over the past 12 months. On an annual basis, this translates to 0.08 percent of dead-weight loss from DRIPs in the ETF structure.

Premiums Can Get Costly

Premiums and discounts add risk. IST’s spreads are not always centered around iNAV. On Oct. 1, 2014, IST’s bid/ask midpoint ranged from 1.31 percent premium to a -0.04 percent discount to iNAV, all in the first half hour of trading. After 10 a.m., all of IST’s underlying securities stop trading for the day, and iNAV becomes stale and irrelevant.

If those 202 shares of IST traded on the open were actually Vanguard’s DRIP buy, then, despite Vanguard’s reliance on market orders, its trader executed well, paying a mere 0.04 percent premium—that’s only 1 penny over iNAV. Still, that’s 0.04 percent more than mutual fund shareholders would pay, if such a fund existed.

Maybe Vanguard got lucky. Over the first half hour of trading in IST, when premiums and discounts are measurable, trades printed anywhere from a 0.67 percent premium for some odd lots, to a -0.16 percent discount.

Clearly, premiums add risk for DRIP investors.

 

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