Smart alternative

There is a group of exchange traded funds (ETFs) that are designed to deliver extra income above what is available from the Australian sharemarket. They are known as smart beta exchange traded products (ETPs). Just as active value fund managers seek out companies and strategies or “factors” that will deliver a higher return, so too do smart beta ETPs. Their number is growing and there are currently about 25. Of these, 13 are screened or weighted to dividends.

There are lots of advantages to buying smart beta ETFs. First off, instead of paying active management fees, you pay less for funds that are listed on the ASX. Technology allows ETFs to deliver what active managers do for a fraction of the cost – a big advantage for investors.

It is hard to know what an active fund manager invests in because they claim that revealing their shareholdings threatens their competitive advantage, while the ETFs reveal all the investments to investors. Smart beta funds are far removed from plain vanilla ETFs that hug an index. This means it can be tricky to choose the right smart beta strategy.

On the Australian sharemarket there are around a dozen ETFs that target Australian companies with good dividends, and there is an international high-dividend payer too.

Alex Prineas, associate director of passive strategies at Morningstar, says high-dividend ETFs are keenly sought because of the low interest rate environment since the GFC. But he says that you can’t look at the product name and assume they will all deliver the same results. Each dividend ETF has a different tilt in an effort to weed out any dividend trap, he says. This explains why the highdividend (or high-yield) ETFs produce a variety of returns. It means that they can be a bit like actively managed funds if you want market-beating returns; the key is picking the right one.

For example, the Australian equity dividend VanEck Vectors S&P/ASX Franked Dividend fund (FDIV) considers franking tax credits in its index construction process. Some dividend ETFs such as Russell High Dividend Australian Shares (RDV) includes A-REITs, unlike others such as Vanguard Australian Shares High Yield (VHY).

Investors need to be aware whether the smart beta factors are cyclical. “What has performed well in the past isn’t necessarily going to perform well in the future,” says Prineas. They need to manage their investments, rather than passively hold them as with index ETFs.