Understanding dividends and ETFs
Self-managed super fund (SMSF) investors have been among the most enthusiastic of all supporters of both passive and Active Exchange-Traded Funds (Active ETFs).
According to ETF house BetaShares’ latest Investment Trends ETF Report
a total of 38 percent of all ETF holders invest in these popular instruments through an SMSF.
New SMSF investors enter the ETF market all the time; the report shows 13 percent of all ETF investors through an SMSF were first-time investors in the last year.
But ETFs have also demonstrated longevity in SMSF portfolios. The same research shows 55 percent of SMSFs that invest in ETFs have been in the market for between four and five years.
As at September 2016, there were more than 100,000 SMSFs that had invested in ETFs.
Given the strong appetite SMSF members have demonstrated for ETFs and Active Exchange Traded Funds (Active ETFs), it’s important for trustees to look under the bonnet of this popular investment vehicle to ensure they genuinely understand how they work.
One of the most important aspects of ETFs to understand is how they treat dividends.
As Greg Einfeld, a director of SMSF specialists Lime Super explains, an ETF typically buys shares in listed companies to replicate an index such as the S&P ASX200.
“The ETF will receive dividends from the companies in which it has invested throughout the year. It will also realise some gains from time to time when it sells assets,” says Einfeld.
“On a regular basis, for instance quarterly or half yearly, the ETF will pay dividends to its investors, which will represent the dividends and realised capital gains from its investments,” he explains.
The process is the same whether an ETF is passive or active. This is because as both passive and active ETFs are structured the same way legally as unit trusts the way distributions are paid are identical. So income and franking credits earned by the underlying exposures in the ETF are paid out to unitholders rather than retained by the trust.
However, active ETFs sell their investments more frequently, so they realise more gains and therefore generally have larger distributions.
“In contrast,” says Einfeld, “passive ETFs will typically pay lower dividends and have higher unrealised capital gains.”
Alex Vynokur, ETF provider BetaShares’ managing director, explains one of the major benefits of ETFs is that dividends and franking credits earned on the underlying shares are passed through to unitholders.
“This means that an investor is no worse off from a dividend perspective by using an ETF versus holding those shares directly. In addition, there are a number of products now available on the ASX that specifically target high income and franking credits for those investors seeking this as an investment goal,” he adds.
Investors interested in the level of distributions historically paid by their ETFs should refer to the ETF issuer’s website, which will typically have information about past distributions as well as historical yield figures.
Says Vynokur: “Dividends and franking credits are collected by the ETF issuer and then paid out at regular intervals just like ordinary shares.”
Every fund has a different schedule so it’s worth checking each ETF in which you have invested to get a proper understanding of how the dividends from the ETFs you own will flow through to your fund.
“Just like shares, an investor will receive a distribution statement at every distribution period detailing the amount of distribution paid and associated franking credits, as well as a tax statement at the end of the financial year,” Vynokur adds.
ETFs are expected to remain popular with investors thanks to their simplicity, low cost and increasingly extensive universe of investment opportunities.
While it’s important to understand how dividends work within them, it’s also essential for SMSF trustees to fully appreciate many of their other attributes.
Theses include how ETFs markets are made and how they operate during market corrections.
As with any financial products it’s also essential for SMSF members to ensure the issuer has long-term experience in financial markets, and a track record in ETFs.
If trustees are satisfied they fully understand how the ETFs to which they are allocating funds operate, there is no reason why they should not form part of an SMSF portfolio.