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Jan 4, 2023

Insights From ETFs 2023: What to look out for.

by Barkha Rani


What a year it was. After two years of lockdowns and abnormal lifestyles, we played ìcatch upî across many areas this year. Metaphorically, government stimulus and pandemic derivatives have also been catching up in the name of inflation and rising living costs.

Exponentially rising inflation forced major central banks around the world to shift to hawkish tightening monetary policies. North America, which has for the past decade seen very low-interest rates (close to zero for most of the decade), is going through a regime shift with rising interest rates. As such, we saw relatively higher pressure on equities, bonds, and many asset classes. 

The S&P500 is off by 15% this year, while the S&P/TSX Composite Index has managed to end the year at a relatively better -3.5% return year-to-date. The Toronto Stock Exchange (TSX) was supported by the commodities and energy sectors. Despite the slump and likely after the tax loss harvesting season, now is a smart time to strengthen a portfolio with good-quality broad-based Exchange-Traded Funds (ETFs) that trade at a relative discount and decent valuations. Below we highlight some ETFs:

Dividend Aristocrats

Dividend aristocrats are defined as companies that consistently pay and grow their dividends over time. The willingness and ability to pay a portion of their profits back to shareholders consistently make them quality picks. The term does not necessarily equate to high dividend payers, given that the dividend can and might be unsustainable, but rather with such ETFs, there is a greater likelihood of consistent dividend increases in the future.

iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ) tracks the index with the same name, which screens the broad S&P/TSX Composite Index for large-cap Canadian companies that have increased cash dividends every year for at least five consecutive years. CDZ has a trailing twelve-month yield of 3.69%, much lower than a high dividend ETF such as VDY FTSE Canadian High Dividend Yield Index ETF (VDY) at 4.17%. The top five holdings include Slate Grocery Real Estate Investment Trusts (REIT), Pembina Pipeline Corp, Keyera Corp, Enbridge Inc, and Fiera Capital.

Vanguard Dividend Appreciation Index Fund (VIG) tracks the S&P U.S. Dividend Growers Index, which screens for companies that have increased their dividend payments for at least ten consecutive years. Over the past decade, VIG has returned nearly 12.51% annualized and offers a trailing twelve-month yield of 1.81%.

Broad-Market Funds

These funds include some of the largest companies within regional or sector focus, and given this year’s turmoil, this would be a good chance to add these ETFs to your portfolios due to their relative safety and diversification.

SPDR S&P500 ETF Trust (SPY) was the first ETF introduced in the U.S. in 1993. The ETF replicates the index, tracking the stock performance of 500 large companies listed on the stock exchanges in the U.S. It is one of the most followed equity indices and is often referred to as “market return” for the U.S. Over the past ten years, the fund has returned 13.21% annually and, on a trailing basis, yields 1.51%.

iShares Core S&P/TSX Capped Composite Index ETF (XIC) aims to reflect exposure to the entire Canadian market by tracking the index with the same name. With a capped weight of 10% on all the constituents, the benchmark, S&P/TSX Capped Composite Index, covers approximately 95% of the Canadian equities market. Given the fund’s (and benchmark’s) relatively overweight exposure to financials and energy sectors, the ETF boosts a solid trailing yield of 2.85% for a broad index-based ETF. XIC has returned nearly 8.49% each year for the past ten years. The top five holdings include Royal Bank of Canada, Enbridge Inc, Canadian National Railway, and Canadian Pacific Railway.

This has been a difficult year for many, and major headlines are already lined up for 2023, including hawkish central banks, rising interest rates, China’s zero-COVID policy, soft landing, and recession. The above-mentioned ETFs tend to perform relatively better than others due to their broad-based nature, diversification, and holdings (largest companies). If your risk tolerance is low and you have no major preference for a select factor or sector, we think these ETFs fit the bill and can reduce a portfolio’s overall volatility.

Barkha Rani CFA, Investment Analyst, 5i

Disclosure: Authors, directors, partners and/or officers of 5i Research have a financial or other interest in XIT and ZRE.