Mind the income ETF performance gap

We explain why year-to-date the best global income ETF is up 8%, but the worst has lost 22%.

It has not been a good year for investors seeking income. Dividends have been cut across the board, while the share price of many dividend-paying stocks have been particularly harmed by the pandemic and resulting global recession.

As you would expect, the poor environment for dividends has translated into poor performance for most global equity income ETFs. Between the start of the year and the end of September 2020, the MSCI World High Dividend Yield NR USD has produced a negative return of -8.24%.

However, what is interesting is how dispersed the performance of different global income ETFs have been. Performance among this group of ETFs ranges from losses of more than 20% to a gain of over 8% so far this year, as the table below shows.  

Source: Morningstar

Such wide variation in returns may be expected when looking at a group of active managers, with each fund being overweight and underweight on different stocks based on the fund manager’s views. However, passive funds tracking the same asset class should, in theory, have relatively similar returns.

So, why did performance differ so much between global equity income ETFs? The simple answer is that each is tracking its own indices. This is true for ETFs of all asset classes – ETFs covering the same asset class can experience differences in performance depending on the specific index they are mirroring.

For example, the MSCI Emerging Market index has a roughly 12% weighting to South Korea, while the FTSE Emerging Index does not. As a result, investors in an iShares emerging market ETF (which tracks the MSCI index) may see better or worse performance than investors using a Vanguard emerging market ETF (which tracks the FTSE index), depending on how well Korean equities do.

However, the difference between indices is even more pronounced when it comes to income funds as there is much less consensus on how to construct dividend-paying indices.

The numerous ways to approach this (for example, filtering based on yield, dividend track record, etc) means there are a range of indices being used by global income ETFs, with several fund houses even using their own. In particular, many indices use a quality screen to avoid potential value traps – shares with high yields that look unsustainable. However, this can lead to very different indices.

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As Jordan Sriharan, head of the managed portfolio and passive services at Canaccord Genuity, notes: “The quality style bias is more subjective [than other style biases].”

This means a wider range of methodologies and, therefore, specific stocks included in the index, which in turn means a much wider range in performance for income ETFs.

Take the two opposite ends of the table. One of the better performing ETFs has been Fidelity Global Quality Income ETF (LSE:FGQD). In contrast to the losses suffered by most ETFs in the table, its performance has been flat so far this year.

This is the result of the ETF being weighted towards better-performing stocks. As the name suggests, this ETF has an additional quality screen. This screen has given it a greater tilt towards technology stocks, with its top two holdings include Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT), helping explain its relatively decent performance.

In contrast, the SPDR® S&P Global Div Aristocrats (LSE:GBDV) has lost investors more than 22% this year. The ETF is intended to follow the S&P Global Dividend Aristocrats Quality Income Index, which is an index screened for higher-quality stocks.

As the ETFs factsheet notes, the index is “designed to measure the performance of high-dividend-yielding companies within the S&P Global BMI that have followed a managed-dividends policy of increasing or maintaining dividends for at least 10 consecutive years and simultaneously have positive return on equity and cash flow from operations”.

However, this approach has not worked in its favour during the dividend drought. Moreover, despite the index having some “quality” screening aspect to it, compared to the Fidelity ETF it holds a lot more traditional high-yielding stocks.

The ETFs largest holding is Dominion Energy (NYSE:D), while its sector breakdown reveals a 26% weighting to financials and 14% to utilities. In comparison, the Fidelity ETF’s biggest sector weighing is tech, at around 20%.

This makes both ETFs very different beasts, despite purporting to provide the same thing: providing exposure to dividend-paying companies. Both hold stocks with very different characteristics and, hence, have very different returns.

This is not to say one is inherently better than the other. The point is that in the current environment the Fidelity ETF has provided better performance owing to the index it follows. It has a higher exposure to quality and, therefore, tech stocks, which have broadly done well this year. However, this does come at the expense of a lower yield.

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Meanwhile, the SPDR® S&P Global Div Aristocrats ETF has much more of an exposure to traditional high-yielding value stocks.  A positive of this is that it generally has a higher yield, which is presumably what investors in global equity income ETFs want. The downside is that it means a high exposure to value and cyclical stocks, neither of which have held up well in the pandemic. The ETF (and the stocks it holds) may have a higher yield, but it can also come at the expense of capital loss.

This can also be seen in the other ETFs. For example, the Vanguard FTSE All-World High Dividend Yield UCITS ETF is among the worst performing, losing investors 12%. Again, this ETF has high exposure to cyclical and value stocks, with its largest sector weighting being financials.

As readers should be able to see from the table, generally the better performers are those with “quality” in their name, suggesting that they have more enhanced quality screens and less exposure to the sort of stocks dragging the SPDR® S&P Global Div Aristocrats ETF down this year. However, it is not always immediately apparent what sort of income exposure investors can expect. With so many different ways to construct an equity income index, investors need to be aware what they are actually buying.

The higher quality screen is not necessarily superior – it has just performed better in current market conditions. The sort of stocks with higher yields have been hit hard in the pandemic, with the relative underperformance of value stocks compared to quality and growth exacerbated. As a result, anyone chasing high-yielding stocks has now faced capital loss.

However, when (or perhaps whether) value stocks ever start to perform better again, the fortunes of the high-yielding income ETF should start to pick back up. Trying to time such market changes, however, is incredibly hard.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.