Factor based approach to Global Dividends, getting under the hood.

Ahmed Farooq, CIMA®, CFP

Ahmed Farooq, CIMA®, CFP
Vice President - ETF Business Development at Franklin Templeton Canada

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A deep dive into the dividend selection process

In my previous article, I wrote about the current market environment and why Canadian investors might consider the benefits of a global dividend investment strategy for their portfolios this year. Now I want to explain a bit more about the Smart Beta strategy that makes the Franklin LibertyQT Global Dividend Index ETF unique. This should help you understand the dual benefits of companies offering high yield coupled with the stability associated with quality global franchises.

Not all dividend strategies are created equal

First, let’s look at popular two dividend-oriented types of investments: high-yield and dividend-growth.

A high-yield dividend company is one whose dividend yield is higher than that of its benchmark. Traditional high-yield stocks have performed strongly in recent years; however, in the current rising rate environment, many have become overvalued and overpriced. In an ultra-low interest rate environment, many of these businesses were able to take on more debt to expand their operations and sustain their high dividend payments to investors and/or increase debt simply to finance yields.

Dividend-growers, on the other hand, are companies that have a demonstrated history of increasing their dividend payouts. While some investors prefer the income produced by high-yield strategies, many investors are equally interested in benefitting from the stability and quality associated with dividend growth strategies.

Our unique approach

During periods of market uncertainty, there may be a “flight to quality” as many investors look to reduce risk in their portfolios. FLGD can help investors minimize these risks by focusing on high-quality, dividend-paying companies from around the world. Here is an overview of the two-step screening process that FLGD uses to filter for quality companies paying above-average yields. Through this robust filtering approach, FLGD seeks to deliver reduced volatility and stable income. 

STEP 1. General Dividend Filter

This filter screens for companies in the MSCI ACWI (ex-REITS) Index that demonstrate attractive dividend histories. During this screening process, the fund managers look for:

  • Dividend Sustainability— Companies that have a five-year+ track record of consistent or rising dividends.
  • Higher Dividends—Companies that have grown their dividends by at least 1.2 times the benchmark growth rate over the past five years.

 STEP 2. Smart Beta/Quality Filter

This second filter focuses only on quality to further screen companies that have passed through the general dividend filter, to:

  • Higher Yields – High-quality companies paying above-average yields.
  • Attractive Risk/Return Characteristics – Companies that can help to reduce portfolio volatility and improve capital appreciation potential.

 This second quality filter overlay further reduces the universe down to the portfolio’s final 100 holdings, systematically ruling out “problematic” companies by identifying these outliers through an assessment of balance sheet and general financial statement health. As a result, FLGD is constructed to hold a healthy representation of highly reputable “global titan” companies, such as Zurich Insurance, Novartis and GlaxoSmithKline (as of February 21, 2018).   

Here is a comparison of the portfolio characteristics of the holdings in FLGD with those of the MSCI All Country World (ex-REITS) Index.

Portfolio Characteristics

I hope that taking a look under the hood of FLGD’s approach to portfolio construction can help investors understand how this ETF offers a higher return on equity, higher dividend yield, lower price-to-earnings multiple and lower beta than the index. Investors looking for an ETF that focuses on the dual benefits of high yield coupled with the stability and quality of global dividend growth should find FLGD a very compelling option.

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What Are the Risks?

Commissions, management fees and expenses may all be associated with investments in ETFs. Investors should carefully consider an ETF’s investment objectives and strategies, risks, fees and expenses before investing. The prospectus and ETF facts contain this and other information. Please read the prospectus and ETF facts carefully before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors. The indicated rates of return are the historical annual compounded total returns including changes in share or unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

Ahmed Farooq’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.