Why dividend ETFs are pulling investors in

Canadian banks continue to defy skeptics regarding the gravitational pull on their earnings from a combination of over-indebted consumers and an underperforming domestic economy, with several of them kicking off 2014 by hiking their dividends while reporting solid first-quarter results.

Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and Toronto-Dominion Bank all boosted their payouts on the strength of strong capital markets and wealth management results, but dividend-seeking investors should still consider diversifying even though the banks make it easy not to.

There are numerous exchange-traded-fund options if you like dividends. If you want banks, how about six of them? The BMO S&P/TSX Equal Weight Banks Index ETF (TSX/ZEB), with assets under management of more than $600-million, provides exposure to the Big 6, rebalanced semi-annually (to equal weight).

But there are plenty of alternatives.

The iShares Dow Jones Select Canada Index Fund (TSX/ XDV) was the first dividend ETF in Canada and is still the largest, but more recent products provide alternatives in terms of breadth of exposure (sectors), methodology (dividend growers versus payers; actively managed or not), geographies (Canada, the U.S., EAFE and now Europe) and, finally, currency (Canadian dollar hedged or non-hedged; Canadian dollar or U.S. dollar).

There is a simple reason for the influx of such products. Dividend stocks — pariahs in the mid-to-late ‘90s — have long since been vindicated, with their contribution to total returns estimated at 40% if not more in recent years.

Another reason is that boomers have a keen affinity for dividends and, unless you want to be the first one to forecast that cash flow won’t matter when they retire, this is a love affair that isn’t going away anytime soon.

This is clearly being reflected in the ETF space in several important ways, most notably in the continued growth and breadth of dividend-focused products. A few years ago, there was but one, now there are close to 30.

Flows into dividend ETFs have also significantly outpaced those into the broader equity ETF category, confirming the saying that investors like to get paid while they wait — if they are, in fact, waiting. Chances are, they just like getting paid, period.

Aside from contributing meaningfully to total returns, dividends also tend to expose investors to some added benefits, especially the potential for reduced volatility.

Most dividend ETFs pay particular attention to avoiding the high-yield trap, that is a company whose dividend yield has just taken off as its share price declined, which is often a sure sign a dividend cut is in the cards. Such a development would introduce the kind of downward volatility investors absolutely want to avoid.

If you are a boomer looking for cash flows, diversification and a methodology that tries to shelter you from nasty surprises, sharpen your focus on dividend ETFs.