TDIV Falls Short for Both Income and Growth

by Dan Burrows | March 14, 2013 6:30 am

The technology sector isn’t just the biggest part of the market by market capitalization — it’s now the single-largest source of dividend payouts in total dollars.

Naturally, that has folks looking to tech as vehicle for both growth and income … and who doesn’t want that? It’s the Holy Grail of long-term investing.

Just as naturally, exchange-traded funds want to get in on the act. ETFs might be the best financial innovation of the last couple of decades, but they’re also growing like kudzu — spreading into niches and crannies where they might do no good.

Apple (NASDAQ:AAPL[1]) is set to be added to the Nasdaq Technology Dividend Index, along with a bunch of other tech dividend-payers. That means anyone holding the relatively new ETF that tracks the index — First Trust Nasdaq Technology Dividend Index (NASDAQ:TDIV[2]) — will get exposure to Apple too.

And in the short term, adding Apple to TDIV only reinforces a key problem with TDIV: that it is not yet compelling enough on the income side of the equation vs. cheaper alternatives within the tech sector and broader market.

TDIV was only launched last August and it already has over $70 million in assets, so clearly it’s found more than a toehold in the market. But it’s still small, does relatively low volume and — importantly — is comparatively expensive.

True, the net expense ratio of 0.5% could come down once it gets big enough for economies of scale to kick in. But until then? Why is it a better ETF for tech and income than … say … the Big Kahuna of tech ETFs: the Technology SPDR (NYSE:XLK[3])?

Especially after TDIV adds Apple?

Yes, TDIV is up 11% for the year-to-date, outpacing XLK by more than six percentage points. But that’s partly attributable to the fact that — unlike XLK — it doesn’t have Apple weighing it down. (Apple accounts for about 14% of XLK’s assets.)

Meanwhile, TDIV’s dividend has a current yield of 1.88%. XLK’s current yield, based on its most recent distribution, stands at 2.25% and XLK only has a net expense ratio of just 0.18%.

So, despite its dividend-seeking characteristics, TDIV actually yields less than XLK since it costs significantly more — $5,000 for every $10,000 invested vs. $1,800 per $10,000 for XLK. And it’s outperformance has been aided by not having Apple … a stock it’s about to add.

To be fair, TDIV has a very short operating history. The dividend profile will change, with payouts becoming more generous as the index it tracks adds more names. Plus, Apple is indeed cheap at current levels. It may have farther to fall, but based on cash on hand and cash flow alone, it’s undervalued and will revert to the mean … eventually.

And in the long run, even Apple’s dividend will help lift the ETF’s total payout. But then again, the tech sector as a whole is becoming much more generous with dividends. As much as TDIV looks to serve as a way to grab more of the income part of the sector, that might be unnecessary. Tech pays a lot of dividends as it is.

Taking a step farther back, what’s the compelling reason to own TDIV over the broader market, which has been offering growth, dividends and superior diversification? It’s not like the S&P 500 ETF (NYSE:SPY[4]) has been a slouch. It’s up more than 9% for the year-to-date and offers a current yield of 2%.

TDIV isn’t a bad idea, but retail investors can easily take a wait-and-see pass on it for now. The short operating history, relatively high expense ratio and ample alternatives for cheaper, less risky exposure to growth and income mean it’s not clear why a retail investor would need it at all.

As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.

  1. AAPL:
  2. TDIV:
  3. XLK:
  4. SPY:

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