Looking under the bonnet of your Equity Income ETF

Arian Niron

Arian Neiron

Investors are increasingly interested in equity income strategy exchange traded funds (ETFs) for two main reasons.

Firstly to capitalise on dividend income and secondly to get instant diversification benefits, according to Arian Neiron, Managing Director, Market Vectors Australia.

However, investors must ‘look under the bonnet’ of equity income strategy ETFs to understand the securities and performance of the underlying index.

The banks have typically been a key source of dividend income and franking credits for investors including self-managed superannuation funds (SMSFs).

“Australian investors have a huge appetite for bank shares because they represent an opportunity to earn yields in excess of cash while also reaping potential capital gains. There is a range of ETFs listed on the ASX which provide investors with access to dividend income with the majority exposed to the Australian banking sector. However, each ETF is structured differently,” Mr Neiron said.

“Investors need to do their homework and understand the underlying index that the ETF tracks. It is important to ask questions such as how much exposure does the index provide to Australian banks, what is the recent performance of the index and what is the ETF actually holding.”

Market Vectors Australian Banks ETF (MVB) is based on the purpose-built Market Vectors Australia Banks Index, which caps any one bank’s weighting at 20%. The index provides exposure to a minimum of six Australian banks offering more diversification across the sector. Currently, the index and MVB holds seven banks.

As a result of its purpose-built index, Market Vectors Australian Banks ETF has outperformed ASX-listed equity income ETFs over the calendar year-to-date (YTD) to 31 May2014[1].

“Market Vectors Australian Banks ETF returned 5.88% YTD to 31 May 2014. The best equity income strategy ETF returned 3.92% for the same period. From the beginning of January 2014 to 31 March, MVB returned a whopping 11.04% – well ahead of the ETFs employing equity income strategies.

“Many of the equity income strategy ETFs are highly exposed to the Australian banks, however MVB’s capping methodology at 20% provides more balanced diversification across the banking sector and also removes the large capitalisation biases that can be found in traditional market capitalisation weighted indices. This methodology has translated into higher overall performance,” Mr Neiron said.

“Investors know that with MVB they are investing in an ETF that is purely banks and therefore they will understand how the ETF’s performance will behave. It is essential that when investing in an ETF investors know what the underlying securities comprise. For example if the ETF regularly or substantially holds derivatives, it may not perform in line with expectations,” Mr Neiron said.

On the cost side, MVB is one of the most cost effective equity income ETFs listed on the ASX at 0.28%, making it a hugely attractive investment opportunity for advisers and SMSF investors.

“Given the level of exposure to Australian bank shares, we believe investors can utilise MVB for both equity income and capital growth in their portfolio without the risk of picking the wrong bank,” Mr Neiron said.

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