If there’s one thing we’ve learned running ETF Watch it is that we Australians love dividends. Our posts about dividend ETFs generate the most traffic, dividend focused ETFs are consistently searched for, and our dividend targeting feature in our fund database is one of our most popular. With Australia’s generous dividend imputation system and a share market that traditionally has a high dividend payout, as well as our low interest rate environment, it’s no surprise that we love dividends.
When we took a look at the ETFs with the highest inflows in the 2017 Financial Year, many of the usual suspects were high on the list. Broad based index ETFs and the one cash ETF available at the time were at the top of the list, however there was one surprise to us high in the list. At number three in the list was the Betashares Dividend Harvester ETF (HVST), an ETF we expected to occupy a small niche, but one that accounted for $277m in fund flows in FY2017, making it one of the biggest ETFs in Australia. We take a bit of a look at dividend harvesting strategies below.
Dividend harvesting strategies seek to buy shares in companies just before they pay their dividends, and sell them soon after. By doing this the investor is able to pick up the cash from the dividend, the associated franking credits and hopefully the fall in the share price is less than the dividend received. As a result the investor can harvest or ‘strip’ the dividends from the stocks, pick up a stack of franking credits along the way and receive a better return than by just buying and holding. There’s some other rules that apply to make this work, such as having to hold the shares for 45 days in order to be eligible for the franking credits.
Whilst there’s a number of ETFs on the ASX that focus on high dividends (we took a look in an earlier post), the only one that is a specific dividend harvesting focused ETF is the previously mentioned HVST. HVST launched in November 2014 and now boasts over $360m in funds under management.
The Betashares Australian Dividend Harvesting fund employs the dividend harvesting strategy as outlined above, as well as a risk management strategy to limit downside risk. This involves using derivatives to limit downside risk.
We’ve got just under 3 years worth of share price and dividend history for HVST, certainly not enough to understand its long term viability, but enough to gain a pulse check on how the fund has performed to date. To accurately compare HVST performance compared to the benchmark funds, all three of share price, dividends and franking credits must be considered, as with dividend harvesting strategies in particular a large proportion of returns will be from franked dividends.
The chart below compares HVST to our benchmark fund the SPDR S&P/ASX 50 Fund (SFY), one of the oldest ETF in Australia and vanilla S&P/ASX 50 index tracking fund. We have chosen this rather than an ASX200 fund as HVST invests primarily across the top 50 stocks on the ASX. It assumes all dividends are reinvested, and grosses up the dividend reinvestment by the franking credits available to investors. Whilst not technically feasible (as the franking credits are returned to investors when they lodge their tax returns), we feel this is the best way to gain an apples for apples comparison.
The above chart shows total performance of the two funds was fairly consistent during the first couple of years of HVST listing, however has diverged over the last year. This is explained by the lacklustre performance of many of Australia’s high dividend payers over this period like the big banks and Telstra, with many of the dividend focused funds underperforming the broader market during this period.
After surely having their investor relations lines bombarded with enquiries from investors about HVST’s recent performance, Betashares have released this paper about HVST, which explains the strategy well and where it is likely to outperform and underperform. On page 11, they list sideways markets and concentrated markets as two times where they may underperform. Both of these have played out this year with the market tracking sideways, and their high allocation to banks from March to June (when most banks pay their dividends) being a period where banks significantly underperformed the broader market.
Ignoring total performance for a moment, the total dividend yield of HVST is one of the highest on the ASX, hovering around the 12% per annum mark. With franking credits around 65% of the dividend, this provides a grossed up dividend of around 15% pa, far exceeding that received of the benchmark funds of around 5-6% pa. The high dividend comes at a cost however, and since inception HVST has lost over 30% of its capital value. Investors looking for the sugar hit of the high dividend yield, must take the inevitable loss of capital into account.
Dividend harvesting strategies provide an opportunity for investors to benefit from the franking credits attached to dividends, however this should not be seen as a free lunch. The strategy will result in inevitable decline in capital value over time, and may underperform the broader market if conditions are unfavourable. There are other ETFs available which focus on yield by targeting other high yield strategies, well take a look at these over the coming months.