Last Tuesday September 13th 2011, Claymore launched their new ETF, Claymore S&P US Dividend Growers ETF, traded on the TSX as CUD-T. The Canadian Couch Potato just covered this ETF in a recent post Claymore’s New Dividend Grower. As if there are not enough ETF’s on the Canadian market to entice investors, here is yet another one to ponder or “ruminate” on. Contrary to the trading ticker, this ETF has nothing to do with a cow – it’s a totally different type of animal. I’m a big fan of Claymore’s products, especially their laddered bond ETFs, but not this one.
This ETF tracks the S&P High Yield Dividend Aristocrats Index, made up of the 60 highest-yielding US stocks that have increased their dividends every year for at least 25 years. It is important to note this index is weighted by yield and not by market cap, an important point I’ll discuss further. In addition, since Claymore ETFs trade on the TSX, CUD is traded in Canadian dollars, and further employs a currency hedging strategy. CUD is suitable for Canadians investing in their RRSP’s, since the US dividends would be fully taxable if CUD is held in a TFSA or unregistered account.
Even After All These Years..
The basic premise of the Aristocrats Index (as well as the High Yield version) is that a company listed in the index must have increased dividends every year for at least 25 consecutive years. That’s right send your wife flowers for her birthday 24 years in a row, then forget this year and your toast! The Aristocrats Index does the same thing. A company that misses a dividend increase (or worse cuts the dividend) is out of the game for 25 years! Before you fill up my comments, I’m not going to wade into the debate of the Dividend Aristocrats, because these companies have been solid pillars of the American economy for decades. Where I take exception is with the idea that this is the only screening criteria used for stock selection. But this is exactly what CUD does.
SDY versus CUD
As the Canadian Couch Potato pointed out in his recent post, CUD-T is nothing new. The SPDR S&P Dividend ETF (SDY) has been tracking this index since August 11th, 2005. SDY-N trades on the NYSE, and is therefore traded in US dollars and deemed foreign content. If you don’t care about currency hedging, and feel the Canadian dollar is about as high as it’s going to go, then consider buying SDY instead. You will end up following the same index, but for half the MER (Management Expense Ratio). CUD has an MER of 0.60% (o.68% with taxes), whereas SDY has an MER of 0.35%. As with CUD, holding SDY in your RRSP, where the dividend income is not taxed makes more sense. If you don’t want to gamble on the Canadian versus US dollar, then CUD is the right choice for you.
This CUD Is Skewed
The index CUD tracks should not be confused with the S&P Dividend Aristocrats Index. The Dividend Aristocrats Index uses a market-cap equal-weighting, with no more than 2.99% weighted to any stock. This is similar to how most dividend investors would build their portfolios. As mentioned, CUD tracks the S&P High Yield Dividend Aristocrats Index. The main problem with the high-yield index is it does not employ an equal weighting to each stock. Rather it gives the top dividend payers a higher percentage, in order to create an overall higher yield.
What this strategy does in simplistic terms, is to place the higher yielding stocks as the top holdings, in higher percentages, and the lower yielding stocks as the bottom holdings in lower percentages. Therefore the portfolio of CUD is weighted to higher yielding stocks, which skews the overall portfolio to more risk and volatility. Remember there is no free lunch with dividends. A higher yielding company is paying a higher yield for a reason, therefore: Higher Yield = Higher Risk. Regardless of a 25 year dividend history, you need to look at the company fundamentals.
For example the largest component in this index is Pitney Bowes (PBI), which comprises 4.07% of this index in weighting, with a 7.20% dividend yield. Pitney Bowes has a dividend payout ratio of 89%, a current debt to equity ratio of 1,437.14 (yes you read that correctly), and a beta of 1.12. The company is mired in as much debt as it is worth. The second component of the index is Century Link Inc (CTL), which comprises 3.90% of the index. CTL is a US Telecom giant with a dividend yield of 8.30%, a dividend payout ratio of 142.8%, a debt to equity ratio of 98.63, and a beta of 1.39. The third holding is Cincinnati Financial Corp (CINF) which comprises 3.29% of the index, and has a dividend yield of 5.8%. CINF has a dividend payout ratio of 88.9%, but a much more stable debt to equity ratio of 16.59, and a beta of only 0.55. As you move down the list of the High Yield Dividend Aristocrats Index, the quality of companies improves, but conversely the weighting decreases – hence the higher yield.
The top 5 stocks in the High Yield Dividend Aristocrats Index compromise 17% of the portfolio weight. By investing in CUD you are taking the risk, even if it’s nominal, associated with these higher yielding stocks. Regardless of their dividend history, you are only getting a reward of a 3.68% dividend yield for the extra volatility.
Conversely, CUD underweight’s some of the best US dividend paying stocks such as MCD, JNJ, PEP, AFL, WMT, KO, and a host of others – albeit with a lower yield. For example in this high yield index, McDonalds Corp (MCD) and Coca-Cola (KO) are only 1.5% each of the portfolio weighting, compared to Pitney Bowe’s 4.07% weighting. So in the High Yield Dividend Aristocrats Index, higher risk stocks are given more preference, and the lower risk stocks which still have stable yields, are weighted lower. In the end it all averages out to a 3.68% dividend yield, which for US stocks is quite attractive.
In my opinion, the strategy behind this index seems to be the complete opposite of what setting up a dividend paying portfolio should be. That is building a core of safe and conservative dividend paying stocks, in equal percentages, with a few of those as higher yielding stocks to boost returns. It may give you a lower yield than CUD, but it’s a safer way to go.
Will CUD Outperform the S&P 500?
Is CUD worth the higher MER and cost of hedging? There is no evidence to suggest the High Yield Dividend Aristocrats have significantly outperformed the S&P 500 (which also includes small cap and non-dividend payers). See the chart to the left comparing the past returns of the SDY ETF versus the S&P 500 Index, and you will see the returns are very similar. The reason is simple math – the sum is greater than its parts. CUD follows the same index as SDY, and yet SDY has not outperformed the S&P 500 Index. In other words you can save yourself some MER fees with a simple ETF such as SPY-N, albeit with a lower dividend yield of 2.00%.
Hedging the CUD
As per Claymore’s web page on CUD, it follows the “S&P High Yield Dividend Aristocrats CAD Hedged Index.” Basically, this currency hedging will protect Canadian investors from a falling US dollar. But if the US dollar rises against the Loonie, then you will not benefit from currency hedging. There is really no right or wrong answer to using a currency hedging strategy when buying US securities – it’s really a personal decision. But right now most Canadian investors are buying US stocks in US dollars, because of the high Canadian dollar.
If you don’t like the idea of speculating on the rise or fall of either currency, then hedging makes perfect sense as you will basically reduce all volatility (potential losses) of any currency fluctuations. In this case, CUD is the right choice. But you may also miss out on a nice gain if the US dollar rises against the Canadian dollar. For the latter SDY makes more sense.
You Don’t Need To Chew CUD
As mentioned you can buy SDY instead of CUD, for half the MER. However, investors interested in dividend paying stocks don’t need either CUD or SDY. They can go buy some of the constituents themselves, such as MCD, KO, PEP, ABT etc. with a discount brokerage account. And many investors could probably do it for less than the MER (Management Expense Ratio) of 0.60% (0.68% with taxes) which CUD charges. The Passive Income Earner provides a list of the US Dividend Aristocrats. There’s no complexity there, pick your favourite stocks and away you go. You certainly don’t need to own 60 stocks like CUD, or 42 stocks like SDY, to have a solid dividend paying portfolio. Even ten of these stocks will give you a nice solid portfolio with a good dividend yield.
I’m certain for many investors this new ETF from Claymore, CUD-T, is exactly what they are looking for, a chance to purchase US Dividend Aristocrats for their RRSP. It may suit their investment objectives perfectly – those looking for income and dividend stock diversification, or without the capital to buy individual stocks. As well a 3.68% dividend yield is quite attractive for a basket of US dividend paying stocks. Claymore has also added currency hedging to CUD in order to protect Canadian investors from currency fluctuations. At the end of the day CUD is a very interesting new ETF from Claymore, but I need more time to “ruminate” on this one. So far it’s not a Ninja buy.
Readers, what’s your view? Are you going to chew the CUD?