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Income Investor: the cost of global diversification

Citywire's yield-hunting columnist has found a way to get global exposure to high-yield dividend shares - at a cost.

 
Income Investor: the cost of global diversification

Most investors think about diversifying their portfolios to reduce the risk of a catastrophic loss. I myself invested too much of my high-yield dividend portfolio in UK banks, including RBS (RBS.L), and was hit hard by the 2007/8 crash that punished them particularly severely. In contrast, Warren Buffett has talked about the benefits of targeting investments - figuratively putting all your eggs in one basket and then watching it very carefully.

Buying the market

As I understand it, investment theory suggests that after diversifying to about 20 different holdings, the benefits of a more varied portfolio result in diminishing safety returns. It is also true that the more stocks (shares) you hold in a particular market, the closer your expected return will approach the market average. However, I have never been happy about ‘buying the market’ with a simple market tracker and I like the high-yield end of the market.

However, we are diversifying to isolate particular risks. Obviously there are business risks associated with particular companies; but there are more general risks associated with currencies and economies. For that reason (and because of some pleasing capital gains in recent months) I have been looking to diversify away from the UK market and shares quoted in British pounds. Of course, many shares quoted in London are of companies with international exposure - but relying solely on these might not give enough geographical spread.

So, imagine my satisfaction in finding an investment that had the following characteristics:

  • 100 different highest-yield dividend shares worldwide (relative to their home market)
  • Diversified across 10 countries and sectors, including America, Europe and Asia/Pacific
  • Stocks are screened by historical non-negative dividend-per-share rates and dividend to earnings-per-share ratios
  • The constituents are weighted by their indicated annual net dividend yield and are capped at 15% of the index’s value

One ETF does the job

It is an Exchange Traded Fund (ETF), of course - the db x-trackers Stoxx Global Select Dividend 100 UCITS ETF part of the Deutsche Bank UK ETF stable. Quite a mouthful, but it seems to be the only ETF quoted on the London Stock Exchange that offers this degree of international diversification in high-yield dividend shares: the only other similar ETF seems to be the iShares STOXX Global Select Dividend 100 ETF, which appears to be only available on the German stock exchanges.

But this is not quite the perfect income-oriented investment. For a start, it doesn’t actually hold any of the shares. Like most of the ‘db’ ETFs it operates with indirect replication (i.e. without directly holding the securities that make up a particular index). By contrast, all the other ETFs I hold use direct replication rather than these complicated derivatives. Whether there is ultimately an increased risk at times of market turmoil remains to be seen. (It is notable that Deutsche Bank is introducing more direct replication ETFs.)

Diversified enough?

This ETF may also not be as diversified as first seems:

  • In November 2012 (according to Morningstar), the heaviest country exposure was the US (25% of the index’s value), followed by the UK (16%) and Singapore (10%)
  • The index is heavily biased to financials which represent 39% of its value, followed by utilities (18%) and telecommunications (14%).

There also seems to be a bit of reliance on real estate: the top three component stocks of the STOXX Global Select Dividend 100 Index are currently:

  • Suntec Real Estate (2.3%) - a composite real estate investment trust (REIT) in Singapore owning real estate that is primarily used for retail and/or office purposes
  • RSA Insurance Group (RSA.L) (2.1%) - the UK stalwart
  • Annaly Capital Management (1.8%) - the largest mortgage REIT listed on the New York Stock Exchange

However, this degree of geographical diversification, does come relatively cheaply, with a Total Expense Ratio of 0.50% (no doubt indirect replication is administratively easier than dealing with 100 different stocks).

The price trend for this ETF has been strongly positive in 2013, after being fairly steady in 2012 - a reflection of the recent uptick in global confidence and possibly a precursor of the much-talked-about 'rotation' from bonds to equities. Of course, with price appreciation, the yield falls - until the next hike in dividends.

The main disadvantage of this ETF is the relatively low distribution yield (for ‘high yield’ dividend shares). The 2012 dividend was EUR 0.95, while the ETF is quoted in UK£ on the London Stock Exchange, so calculating the current yield - I make it around 4.5% (Bloomberg gives it as around 4%). This is lower than I would normally look at and similar to my cash return.

But perhaps that is the cost of diversification. Anyway, I'm hoping that this might be a long-term 'anchor' to help stabilise the equity half of my high-yield portfolio. We shall see.

If you've enjoyed this article, why not visit DIY Income Investor's blog. The views in this article are the author's own, and do not constitute advice.

13 comments so far. Why not have your say?

J Bewey

Feb 04, 2013 at 11:49

Can anyone recommend a physical gold ETF please?

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ermine

Feb 04, 2013 at 12:24

GBSS

http://www.etfsecurities.com/msl/etfs_gold_bullion_gb.asp

But what's the point? If you fear armageddon and the war of all against all, you need your gold in the form that you can grab it and run with it away from the zombie masses. A bit of paper saying you have a claim on x amount of physical gold will be worth ought, for th simple reason that you fail the Stalin question.

Where are your divisions - who will help you press you claim ;)

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BMgreen

Feb 04, 2013 at 17:00

Hi

I enjoy reading your pieces. Good advice. One question - you wrote your cash yields about 4.5%. How do you do that?

Thanks

BMGreen (indeed, very green)

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PensionsManager

Feb 04, 2013 at 20:39

Vanguard FTSE350 High Yield (111 stocks approx). 0.5% stamp duty to get in and 0.25% AMC. Yield circa 4.5%. Good diversified UK focus but with overseas companies that happen to list in London of course. That's what I use.

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Hilary hames

Feb 04, 2013 at 21:50

@Pensions Manager is this an ETF please ? Presume not a fund if you pay stamp duty...

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PensionsManager

Feb 05, 2013 at 06:39

www.vanguard.co.uk - but you can access via platforms such as Hargreaves Lansdown (with a £2 per month charge). They are single priced and a UK OEIC. Income or accumulation variations. Low cost and transparent, that's why stamp duty is shown. There are actually 127 stocks in it according to the fact sheet. If you invest with Vanguard direct you have to meet a minimum investment level, however. Via a platform you have more modest entry limits. It is full replication, not ETF.

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J Bewey

Feb 05, 2013 at 11:21

In reply to Ermine; while physical gold is the better option; my self invested retirement annuity trus fund will not allow me to hold the gold myself nor will the trustees hold it. The charges to do so make it unviable so I need a physical gold etf in this case.

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Christopher

Feb 05, 2013 at 13:19

So J Bewey take some cash out of your SIPP (have you had your 25%?) and buy the gold yourself?

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J Bewey

Feb 05, 2013 at 13:31

Not that simple unfortunately as it is not a SIPP as you know it.

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Income Investor

Feb 06, 2013 at 22:55

BMGreen

You asked about my cash returns. These are a combination of current a/c (3%), easy access (2.%) and a combination of long-term cash savings bonds ranging from 4.5% to 5.2%. Overall average 4.3%.

It will obviously be harder to roll over the cash bonds at such attractive rates..

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douglas gordon

Feb 09, 2013 at 16:54

Thanks Income Investor for another interesting article on an off-beat investment. You have, yet again, unearthed an unusual income-generating investment. What a pity none of the comments relate to the subject of your narrative!

I will attempt to investigate it further as I feel that it might well be worth a smallish punt for diversification purposes, but the yield is surprisingly low, as you say; however, if sterling continues to weaken as the pundits forecast then the yield might prove to be more attractive in the longer term.

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sgjhaghsdg

Feb 09, 2013 at 18:24

I use the Vanguard UK Equity Income Index fund, which might be the one PensionManager means.

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Anonymous 1 needed this 'off the record'

Feb 11, 2013 at 09:22

It is impossible to diversify effectively with equities alone, regardless of their sector or geography

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