You’ve heard it before, but it bears repeating: Be careful with stocks that have high dividend yields.
Those dividend yields may be high because the stock price is low, and it may be low because the market thinks it’s a terrible stock or company.
That’s one reason why I love the explosion in ETF offerings. Instead of having to pick and choose among mutual funds, you can get into dividend ETF examination with a lot more efficiency. Moreover, ETFs give you diversification, sometimes among hundreds of holdings.
Thus, if you have a dividend ETF that targets high yields, you may have less risk involved. If all the investments are in a specific sector, then you do have sector risk, but not individual stock risk, which is minimized. If they are spread more broadly, even better.
Let’s look at the three highest yielding dividend ETFs and see if there’s enough safety in them to consider buying.
iShares Mortgage Real Estate Capped (REM)
The iShares Mortgage Real Estate Capped (REM) is a seven-year-old, $1.3 billion fund that holds 36 securities in the mortgage REIT space. Mortgage REITs hold a variety of residential and commercial mortgages, and make their money by borrowing at historically low interest rates, and then earning the spread between the mortgages they buy with that money and their cost of capital.
This sector is very high yielding, but has a lot of interest rate risk. Because the companies in this dividend ETF are so highly leveraged, if interest rates rise even a little, their net revenue suffers dramatically. This is a very high-risk play, at least for me, and not even the 13.5% dividend yield is enough to attract me.
Even though familiar names like Annaly Capital Management (NLY) and American Capital Agency (AGNC) are listed, I’m not comfortable. Those two holdings alone make up 29% of this dividend ETF, and 36 securities isn’t nearly diverse enough.
Expenses for REM run 0.48% — or $48 for every $10,000 invested.
SPDR S&P International Telecoms Sector ETF (IST)
I’m much more comfortable with SPDR S&P International Telecoms Sector ETF (IST). This dividend ETF seeks to mirror the S&P Developed Ex-U.S. BMI Telecommunication Services Sector Index. This index holds plenty of securities — 66 of them — and are broadly diversified geographical telecom securities pulled from 26 separate market indices.
There are familiar names here like Vodafone (VOD) and Telefonica SA (TEF), with an average market cap of $17 billion. It has a total five-year return of about 55%, thanks to a dividend yield of 12.3%.
I’m comfortable with the diversification and that these telecoms all deliver high yields, as they should, thanks to robust cash flow. I would consider this as a small portion of a long term income-driven portfolio and feel good about its risk profile.
IST costs 0.5% in gross expenses.
iShares International Developed Real Estate ETF (IFGL)
I also think rather highly of the iShares International Developed Real Estate ETF (IFGL). The ETF seeks to mirror the FTSE EPRA/NAREIT Developed Real Estate ex-U.S. Index. This holds 198 non-US real estate securities. More than half are large caps, and 29% are midcap holdings. It is broadly diversified by region, with 26% in Europe, 25% in Japan, 22% in Asia, and 11% in Australia.
I don’t recognize the names, although many trade on the US exchanges. The 11.2% dividend yield has powered a five-year total return of 47%. Expenses run 0.48%.
In this case, I like that there’s an ETF going after real estate in other countries. I want exposure to real estate as a hard asset, and I don’t want to be limited to U.S. companies. Japan and much of Europe are experiencing distressed situations that I want to profit from. I would consider IFGL also as a small part of my international holdings in a portfolio.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets at @ichabodscranium.