Under the Hood: First Asset Morningstar US Dividend Target 50 (UXM)

By Dan Bortolotti and Canadian Couch Potato on August 18, 2012
Estimated reading time: 4 minutes

This post is part of a series called Under the Hood, where l take a detailed look at specific Canadian ETFs or index funds. The fund: First Asset Morningstar US Dividend Target 50 Index ETF (UXM) The index: The fund tracks the Morningstar US Dividend Target 50 Index, which was created specifically for this ETF. [...]

This post is part of a series called Under the Hood, where l take a detailed look at specific Canadian ETFs or index funds. The fund: First Asset Morningstar US Dividend Target 50 Index ETF (UXM) The index: The fund tracks the Morningstar US Dividend Target 50 Index, which was created specifically for this ETF. The methodology screens US companies based on five criteria: expected dividend yield, cash flow/debt ratio, five-year normal EPS growth, return on equity (latest quarter), and three-month EPS estimate revision. To ensure liquidity, all stocks in the index must also be among the top third in average daily trading volume. The top 50 stocks in this screen are then equally weighted in the portfolio (2% each) and rebalanced quarterly. The cost: The fund’s management fee is 0.60%. Because the fund is less than a year old it has not published its full MER, but expect it to be at least 0.68% after factoring in the Ontario Harmonized Sales Tax. The details: UXM is designed to give dividend-focused Canadians a one-stop solution for diversifying into the US market. The index is based on the US Income model portfolio that is part of Morningstar’s Computerized Portfolio Management Services (CPMS), popular with fund managers and investment advisers. The fund uses currency hedging to eliminate exposure to the US dollar. Some of the more well-known companies in the fund include Coca-Cola, Johnson & Johnson, Colgate Palmolive, Chevron, Exxon Mobil, 3M, Pfizer, Merck, Verizon and Caterpillar. At least half are household names, though there are a smattering of lesser-knowns as well. Unlike several other dividend ETFs, UXM does not screen for companies that have a long record of dividend growth, which I think is right approach. While I understand the appeal of dividend growers, is a company that has grown its dividend for 20 consecutive years—which is necessary to be part of the S&P High Yield Dividend Aristocrats Index—really a better investment than one that missed a couple of increases for legitimate business reasons? This part of the Aristocrats methodology strikes me as arbitrary and backward-looking. As it happens, only seven of UXM’s holdings are on the Aristocrats list. Dividend-growth strategies are also biased toward older, mature companies, which in the US effectively makes them dramatically underweight in technology and energy. The sector breakdown in UXM, by contrast, is more similar to that of the U.S. large cap market as a whole:

	S&P 500	Aristocrats	UXM
Financials (incl. REITs)	14.2%	19.1%	10.0%
Energy	11.2%	1.3%	10.2%
Materials	3.3%	10.4%	3.9%
Industrials	10.2%	14.6%	13.7%
Consumer Discretionary	10.8%	11.2%	8.1%
Telecommunications	3.4%	3.3%	6.0%
Information Technology	19.8%	3.2%	10.0%
Consumer Staples	11.4%	19.4%	20.3%
Utilities	3.8%	10.6%	7.7%
Health Care	11.9%	7.1%	10.1%

The ETF was launched in February, so it’s too soon to say anything meaningful about its performance. The fact sheet gives the index yield as 4.59%; however, the ETF’s first two quarterly distributions were $0.0527 and $0.0944 per share. That first dividend does not cover a whole quarter, so if we just annualize the second figure and assume an average share price of $10, that’s a yield of about 3.78%. The alternatives: UXM’s most significant competitor in Canada is the iShares S&P US Dividend Growers Index Fund (CUD), which tracks the index discussed above. The two funds have the same fee, but as we’ve seen, they have very different holdings. BlackRock has also just launched the iShares US High Dividend Equity Index Fund (XHD), which tracks a different Morningstar index. Although XHD holds 75 stocks, it is cap-weighted and its top 10 holdings comprise more than 60% of the fund. Bottom line: In my view, UXM is the best choice for dividend-oriented investors who want an ETF that trades in Canadian dollars and uses currency hedging. Its index focuses on fundamental factors without imposing an arbitrary screen for dividend growth, and its equal-weighting avoids concentration any single company. As a result, it overcomes many of the flaws of its competitors. However, investors who are willing to accept currency risk can find several lower-cost choices among US-listed ETFs, such as the Vanguard High Dividend Yield ETF (VYM). Disclosure: I do not currently own UXM in my own portfolio.