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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.
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.)
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.
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by Gavin Lumsden on Nov 21, 2014 at 14:52