Investing in ETF – Know What You are Investing In

globeAs individual investors, we are always careful of what we invest in and what investing vehicle we use. We try to filter the business media noise or recommendations from analyst or fund house marketing data. In last few years, we have been told that the simple and easiest way to invest in new growing emerging markets is use emerging market ETFs and/or funds. There are so many different funds with so many different themes that we should understand whether we are really getting what we are looking for. Following are few examples as observations on structures of ETFs.

Example 1: VWO and EEM are funds based on MSCI emerging market select index which is market capitalization based index. It includes 18 to 20 emerging economies where stocks can be bought free of any restrictions.

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MLP Asset Class for Dividend Growth Portfolio

This article was originally published on The DIV-net on May 7, 2009

I continue to believe that every asset class has its significance and its own importance. Every asset class has a role to play in investment portfolios. However, individual investors need to understand these factors in the context of their own portfolios. Being a do-it-yourself investor, I like to ignore the market noise and understand how any asset class will affect my portfolio objectives. In earlier posts, I have discussed about my investing approach with respect to commodity asset class, international developed/emerging asset class, and the investment vehicles that I like to use.

Master Limited Partnership (MLP) is another asset class that provides relatively higher yields than compared to commonly known dividends. MLPs were established by congressional act in mid-to-late 1980s to increase investments in energy and natural resource projects. If not always, then in most of cases, there are the companies that are engages in exploration, production, mining, processing, refining, marketing or transportation of mineral and natural resources. These natural resources could be oil, coal, propane, natural gas, timber, etc. Among other, MLP asset class has three significant differences when compared to corporate equities. These differences are: continue reading rest of the article….

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International Equities in Dividend Growth Portfolio

I have discussed about my investing approach with respect to commodity asset class and investment vehicles. International developed/emerging equities are another asset class which dividend investors should include in their portfolios. I have spent some time to read and understand the characteristics of this asset class. In this asset class, i.e. international developed/emerging equities, there are three significant differences when compared to North American domestic equities. These differences are:

  1. Frequency of Dividends – Majority of the domestic equities pay dividends four times a year. The frequency of dividends paid by international equities is less than domestic equity class. At most, these equities provide two dividends per year (and only one in some cases). The implication is it slows down the dividend compounding growth of investments.
  2. Tax Structure – Depending upon the country, the taxation structure is different for each country. In most cases, the tax is deducted at source i.e. at the time of dividend payment. This tax deducted at source can be accounted during US tax returns. Nevertheless, the dividend payment is reduced by that amount. This again slows down the compounded dividend growth.
  3. Currency fluctuations – This is another factor that affects the dividend payment. The dividend may appear to be varying over a period of time, but could be due to currency fluctuations. For true reflection of dividend policy, individual investors should look at the company’s annual reports or dividend information section on website.

 

In general, as with any other asset class, here also I found the usual suspects of investment vehicles such as mutual funds, closed end funds, exchange trade funds, and individual stocks. The fund fees range anywhere from 0.3% to 1.1% (more in case of some mutual funds). One of the common issues that I found with most of these funds is that they use ADR listed on US-based exchanges. To put it mildly, I find this very perplexing, intriguing, and disappointing. If these institutional funds with large resources use the ADRs instead of actual currency in the corporation’s native country, then why should I pay unnecessary fees? What benefit do I have to buy their funds? In addition, in most cases, these funds consists of a more than 60 companies, which range from good to moderate to bad to worse. Investment in these funds essentially means covering the full quality spectrum.

 

Some funds from Wisdom Tree’s ETF portfolio are exception to above observations. Many of Wisdom Tree’s ETFs actually hold equity in corporation’s native currency. However, my concern about fees and capturing full spectrum of quality of corporations still remains.

 

At the time of this writing, I have investments in PID and AOD. While PID is meeting my portfolio requirements, I am not too happy about AOD. When I had initiated my position in AOD, it was an international focused (with 65%+) closed end fund. It changed its allocation to domestic stocks (65%+) over the period of last four months in 2008.

 

If I have to invest in ADRs, then why not invest in individual companies. The three characteristics that I have listed above remain same whether it is fund based investment or individual ADRs. As I mentioned in my earlier post at Dividend Tree, it is not necessary to invest in many corporations for diversification. The diversification can be achieved with few good quality individual equities also. Since the capital allocation to dividend portfolios are for 10+ years, investors should be willing to take relatively higher risk. For my dividend portfolio and individual investor looking for international exposure, I have a shortlist of following international equities (which pay dividends) for further analysis:

  • Unilever PLC (UL) and/or Unilever NV (UN)
  • Cadbury PLC (CBY)
  • ABB Limited (ABB)
  • National Grid PLC (NGG)
  • Nestle (NSRGY)
  • Siemens AG (SI)
  • Vodaphone PLC (VOD)
  • BT Group PLC (BT)
  • CPFL Energia S.A. (CPL)
  • China Mobile Limited (CHL)
  • ICICI Bank Ltd. (IBN)

Individuals should perform further analysis (based on their risk profile) to evaluate how above equities fit into their dividend portfolios. Individual investor’s end goal should be to invest in at least five to six good quality international dividend growth equities.

 

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Commodity Asset Class in Dividend Growth Portfolio

One of basic tenets of portfolio construction is following the principles of asset allocation. This is much more applicable and valid for do-it-yourself individual investors. In this context, at a minimum, I need to look at and at least consider evaluating all possible asset classes. While doing this, I also have to keep in mind that my portfolio is based on dividend growth philosophy. Among others, a commodity is also one asset class which I believe I should be investing. The next question is what should be my investing vehicle.

Since 2001, quite a few commodity index based Exchange Trade Funds (ETF) and Exchange Traded Notes (ETN) were introduced in the market. There are more than 30 commodity ETFs/ETNs of various flavors based on agriculture, raw metals, coal, water, oil, natural gas, gold, silver, different combinations of these in index format, etc. And how can we forget, the biggest sham of all investment vehicles, futures-based index ETFs/ETNs. My viewpoint is, futures-based index are just designed for speculation. As it always happens, during the speculative boom of late 2007 and early 2008, every month a commodity ETF or ETN was launched in market in one form or other. continue reading rest of the article….

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