5 buys: MoneyWeek’s best dividend ETFs

Investors looking for income should take a look at the best dividend ETFs on the market.

ETFs provide flexibility other structures do not, which can make them a good way for investors to build exposure to different market themes.

ETFs vs open-ended funds: What’s the difference?

This subject can be a bit complex, so I will try and keep it as simple as possible. There are really two different categories of investment funds, open-end investment funds and closed-end funds.

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Open-end funds take money from new investors, invest this cash in the portfolio and then issue new shares in the fund to the new investor (shares are bought back when investors exit). This structure means it is difficult to hold less liquid instruments like bonds and small-cap shares as it might be harder to acquire these assets in the quantities required to satisfy investor contributions and deposits.

Meanwhile, closed-end funds have a limited number of shares in issue (although they can issue more). As such, managers always know how much capital they have available to invest, and can deploy it accordingly.

A quirk of this structure is that closed-end funds can trade at a discount to their underlying net asset value if more investors are selling rather than buying (or at a premium if the situation is reversed). That can’t happen with open-end funds as these investors will have their shares bought back.

Investment trusts are a good example of closed-end funds, while Lindsell Train Global Equity is a great example of an open-end investment vehicle.

ETFs bridge the best of both worlds. They have a fixed number of shares in issue, but can issue and buyback stock if needed at any point.

What’s more, unlike most OEICs and unit trusts, shares can be bought and sold at any point in the trading day. This means it is easier for investors to convert their assets to cash. It can take several days to exit open-end funds.

Low costs means more money for investors

A handful of providers dominates the ETF market, which gives the asset class another advantage over traditional funds.

Most ETFs track market indices, meaning costs are quite low to begin with. However, the economies of scale in the industry have pushed costs down even further. Some of the best dividend ETFs don’t track an index, but do offer lower costs than their actively managed competitors.

Still, a disadvantage of using these vehicles is the fact that as most are designed to just track indexes – they won't outperform.

So there are benefits and drawbacks to using ETFs to invest. Some investors might prefer the strategy, while others might want to avoid it altogether.

The best dividend ETFs on the market today

For those investors who think ETFs offer something different, here are the five highest-yielding income ETFs on the market today.

All of the ETFs listed above are designed to track an equity income index. I should also note that the yield figures above are a trailing 12 month historical basis. Therefore, they may not be reliable indicators of future income.

These funds have made it onto MoneyWeek’s list of the best dividend ETFs due to their low costs and high yields.

I also like the international diversification offered by the likes of the Fidelity Global Quality Income ETF and FTSE All-World High Dividend Yield UCITS ETF.

Both of these funds own geographically diversified portfolios of equities. Although their overriding aim is to generate income, their global focus also means that they have a better track record of producing capital growth as well.

The Fidelity Global Quality Income ETF also has a great deal more flexibility in its investment mandate. It does not have to track an index, and so far, this has helped the fund outperform the Global Equity Index benchmark. Over the past five year the fund has produced a total cumulative return of 74% compared to 36% for the benchmark.

The iShares UK Dividend UCITS ETF tops the list of the best dividend ETFs on a yield basis. The £860 million fund is dominated by FTSE 100 dividend giants such as Imperial Brands (LSE: IMB), Rio Tinto (LSE: RIO) and Legal & General (LSE: LGEN).

Owning this ETF could also help investors build exposure to a basket of cheap UK blue-chips. The average price-to-earnings (P/E) ratio of the portfolio is 8.5.

That said, the fund is one of the more expensive options on this list with an ongoing charges figure of 0.4%. While still much lower than the average price investors will pay for an active fund, it’s still a bit on the high side for an ETF.