The FTSE 100 Has Crushed This Crazy Dividend ETF

Published in Investing on 14 August 2012

You can't just sit back and let a fancy mechanical formula select your income investments.

Dividend investing -- like all investing -- still requires human intuition and experience to pick the right companies.

Unfortunately, you can't just sit back and let some sort of fancy mechanical formula select your income investments for you, as holders of the iShares FTSE UK Dividend Plus (LSE: IUKD) exchange-traded fund (ETF) have found to their cost.

The 50 highest yields

For those who aren't familiar with this fund, the Dividend Plus ETF was established during 2005 and attracted a fair bit of interest from many private investors.

The appeal was simple: the ETF would back the 50 highest-yielding shares in the FTSE 350, and buyers just had to wait for the above-average payouts to roll in.

In the early days, the Dividend Plus did well and holders received a rising income.

12 months to AugustDividend Plus dividend (p per share)
200639.82
200747.33
200858.04

Source: iShares.com

But then the banking crash arrived and the ETF's dividends were thumped in the downturn:

12 months to AugustDividend Plus dividend (p per share)
200858.04
200936.11
201033.18
201136.88
201237.78

Source: iShares.com

So what went wrong with the Dividend Plus? Looking back, it's easy to see a number of flaws as the crunch erupted. In particular:

1. The fund's holdings were assessed and weighted purely on published City dividend forecasts, and carried all the inherent risks of such projections;

2. The fund's portfolio was amended only once a year, with portfolio additions and removals limited to just five shares;

3. The fund had no limitation on sector concentration.

Thanks to Fool poster Degsy67, we can look back at the Dividend Plus portfolio as at March 2007. Top 12 positions back then included Lloyds Banking (LSE: LLOY), JJB Sports (LSE: JJB), Woolworths, Dixons Retail (LSE: DXNS) and Alliance & Leicester -- all of which we now know became disaster investments.

Courtesy once again of Degsy67, we can also look back at the Dividend Plus portfolio as at March 2008 -- and this really was a shocker.

The mechanical rules of the Dividend Plus prompted switching some money from stalwarts such as Royal Dutch Shell (LSE: RDSB) and United Utilities (LSE: UU) to banks such as Bradford & Bingley and Royal Bank of Scotland (LSE: RBS).

Worse still, new shares bought by the fund during March 2008 were Barratt Developments (LSE: BDEV), HBOS, Taylor Wimpey (LSE: TW) and Yell -- all of which were hammered six months later by the financial crisis.

New and improved?

Not surprisingly, the Dividend Plus website now shows the fund's methodology (PDF) has been altered following the banking crash.

As far as I can tell, the holdings continue to be assessed and weighted purely on published City dividend forecasts, but now the portfolio is amended twice a year, with portfolio additions and removals unlimited.

However, the Dividend Plus still has no restriction on sector concentration -- and the latest holdings show 30% of the fund is invested in just 'Financials'. Just so you know, current top-10 holdings include RSA Insurance (LSE: RSA), Inmarsat (LSE: ISAT), Aviva (LSE: AV), AstraZeneca (LSE: AZN) and National Grid (LSE: NG).

Dividend Plus versus FTSE 100

To put the performance of the Dividend Plus into perspective, these next tables summarise the fund's performance since its launch against the iShares FTSE 100 (LSE: ISF), an ETF that tracks the FTSE 100 (UKX) index.

 12 months to August 200612 months to August 2012Change
iShares Dividend Plus dividend (p per share)39.8237.78-5%
iShares FTSE 100 dividend (p per share)17.3718.62+7%

Source: iShares.com

 Price 8 Nov 2005 (p)Price 13 Aug 2012 (p)Change
iShares Dividend Plus1,000736-26%
iShares FTSE 100550588+7%

Source: iShares.com

So the Dividend Plus since launch, both in terms of dividends and capital performance, remains well behind the FTSE 100. And looking at how the Dividend Plus continues to pick its income shares, I continue to believe the fund invests in a crazy way and is unlikely to serve holders well.

Old-fashioned common sense

I take two lessons from all of this.

First, fancy mechanical strategies can look great for a short time then easily fall to pieces. If you are a lower-risk investor, I think it's always best to keep things really simple and stick with a FTSE 100 tracker.

Second, human intuition and experience -- as well as common-sense thinking! -- will always be required to succeed with individual shares.

If proof were needed of that, just consider the performance of Neil Woodford, the head of investments at Invesco Perpetual and quite possibly the City's finest dividend-devoted stock-picker.

While dividends from the FTSE 100, as measured by the iShares FTSE 100, have risen 7% between 2007 and 2012, the payouts from Mr Woodford's Invesco Perpetual Income fund have surged 41%.

You see, unlike many investors (and ETFs!), Mr Woodford was smart enough to see the trouble looming for banks and exited the sector long before the bailouts.

To learn more about Mr Woodford's talents and how his dependable style of dividend investing has thrashed the wider market, I would urge you to read this free Fool report -- "8 Large-Cap Dividend Plays Held By Britain's Super Investor".

The report explains how Mr Woodford evaluates individual companies for his portfolio and can be requested to your inbox right now.

Rest assured, Mr Woodford's techniques are based on old-fashioned research and experience -- and not some crazy mechanical approach that can leave your portfolio dependent on duff forecasts, dangerous sectors and dodgy shares!

Baffled by shares? This special report -- "What Every New Investor Needs To Know" -- can start you on the path to investing. What's more, the report is free!

Further Motley Fool investment opportunities:

> Maynard does not own any of the shares mentioned in this article.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Fittster 14 Aug 2012 , 3:18pm

Couple of points

The UK Dividend Plus fund should be compared against a tracker covering the FTSE 350 not the FTSE 100. The article is comparing apples and oranges.

"fancy mechanical strategies can look great for a short time then easily fall to pieces."

A tracker is a mechanical strategy. Is the fool's advice now to go for actively managed funds, even though they under perform in the long run.

AleisterCrowley 14 Aug 2012 , 4:17pm

It's mechanical, but not fancy...
And at least you know you'll nearly match the index you are tracking.

(Although the FTSE100 is effectively a mechanical 'fund' with entry/exit rules and liable to get imbalanced if there's a sector bubble)

MunroMan 15 Aug 2012 , 8:30am

The Fool should look at some of the other process driven, "smart-beta" funds. Not all have been as bad as IUKD.

DonGately 15 Aug 2012 , 8:53am

For a better run alternative, the Vanguard UK Equity Income Index (launched 2009) has outperformed the FTSE-100 /350 over 3 years and the IUKD ETF

Notably it has also massively outperformed Woodfords income funds over 3 years.

It would have been interesting to see how it had fared during the crisis years, but it's preformance over the last 3 suggests it would have fared no worse than any of the alternatives.

All this for TER of 0.24%

OxonianCambion 15 Aug 2012 , 9:12pm

Note that the FTAS or FTSE350 are pretty much the same as the FTSE100 due to the weighting methodology.
Look at the correlation over the last 5 years:
http://www.google.co.uk/finance?chdnp=1&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1345061202472&chddm=649481&chls=IntervalBasedLine&cmpto=INDEXFTSE:NMX&cmptdms=0&q=INDEXFTSE:UKX&ntsp=0

IUKD is a poor fund, but what about the RAFI funds (PSRU / PSRF) or the US Dividend Aristocrats ETF? (USDV). LordEssex might be avoiding mentioning The Munro Fund directly, but I will! (I don't know much about the Vanguard fund but I'd imagine it is excellent...)

Personally I think weighting by market cap is correct for an index, but there should be no reason why this is a particularly good idea for an investment strategy.

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