Investors wrong-footed by BHP Billiton and Rio Tinto's dividend cuts last year were not the only ones ruing their timing.
One of the most popular niche exchange traded funds in the market, the Vanguard Australian Shares High Yield ETF, had large exposure to the mining giants only for the stocks to slash dividends, unwinding their brief and ultimately misguided stint as yield stocks.
Yields, which rise when share prices fall, can sometimes send false signals. And high yields, in the order of 7 per cent or more, send a different kind of signal altogether: it can mean the market has lost confidence in the company's ability to pay its dividend.
Vanguard urges investors looking for yield in the equity market to consider the risk they are taking, equity risk being higher than bonds and cash. It also highlights that specialist strategies carry greater risk than a broader benchmark of 300 securities.
As with most ETFs similar in structure, Vanguard does not choose the underlying stocks. It replicates a specific index, in this case, the FTSE ASFA Australia High Dividend Yield Index, which oversees the companies that are rotated in and out with an emphasis on stocks commanding above-average forecast dividends. This Vanguard "master" fund has $1.56 billion of assets, of which is $686 million is accessed via ETF and the remainder as a conventional managed fund.
Rodney Comegys, head of investments for Vanguard Asia-Pacific, said the product is designed with a recipe in mind. "That's what it's looking for, that's what's inside this product." The fund is rebalanced twice a year, which means fees stay low because the manager is not trading with a high frequency.
When BHP and Rio's share prices fell, they became eligible for the mix in June 2015. Their combined weighting went from 2 per cent to more than 20 per cent of the fund, according to Morningstar research. When their dividends were cut they fell out of consideration in the June 2016 rebalance and were reduced to a 4 per cent weighting. The ETF underperformed.
The high-yield ETF is "not as diversified and it's not as broad" as a top-300 strategy, Mr Comegys said. "It has much more of an active part to it."
He would advise investors to consider high-yield only as a proportion of their portfolio, and be conscious of any creeping concentration risk. "A decent number of Australians and especially a number of self-managed super investors already have a lot of concentration to the large cap Australian names such as BHP and Rio or the banks," he said. Adding the high-yield ETF would only exacerbate that.
Almost 10 per cent of the ETF is in Wesfarmers and 7 per cent is in Commonwealth Bank of Australia. No single stock can exceed 10 per cent of the portfolio and no single sector can exceed 40 per cent.
Highlighting the concentration risk Australian investors face, in Vanguard Total World – an ETF representing the global equity universe – CBA is ranked only at number 60 or 0.22 per cent of the fund. Apple, the world's biggest company, is only 1.41 per cent of its assets.
The ETF market in Australia is booming and its growth is coming from more specialised and esoteric products.
"You have to understand what's inside your portfolio," Mr Comegys said. "We would remind investors including in our own products that these products have much more specific investment purposes and they do take on more risk against the market."
In 2012 and 2013 the high-yield ETF delivered 24.53 per cent and 26.54 per cent returns, according to Morningstar, but has recorded subdued returns since.
