BondsOnline Advisor May 2005
by Stephen Taub
Boosting Income with ETFs

Investors looking to squeeze out a little more income may want to look at exchange traded funds (ETFs), one of the fast-growing investment vehicles.
ETFs are like mutual funds in that they invest in a basket of securities. Unlike traditional open-end funds, they are traded on a stock exchange and can be bought any time during the trading day. So, you must may a brokerage commission.
They can also be sold short and bought on margin, just like any other stock.
ETFs typically track a specific index of stocks or bonds. And their expense ratios are generally very low.
HOLDRs, which stands for holding company depository receipts, is a type of ETF marketed by Merrill Lynch, iShares are marketed by ETF giant Barclays Global Investors, while VIPERs stand for Vanguard Index Participation Receipts, which are ETF versions of Vanguard index funds, according to Morningstar. VIPERs are structured as share classes of existing open-end funds.
According to Dan Culloton, who follows ETFs for Morningstar, there are few bond offerings.
Barclays offers six iShares. One of them tracks the broad U.S. bond market--Lehman Aggregate Bond Fund (AGG). Another one tracks the corporate bond market--GS $ InvesTop Corporate Bond Fund (LQD). And four cover the Treasury market-- Lehman 1-3 Year Treasury Bond Fund (SHY), Lehman 7-10 Year Treasury Bond Fund (IEF), Lehman 20+ Year Treasury Bond Fund (TLT) and the Lehman TIPS Bond Fund (TIP).
The expense ratios on the six funds range between 15 and 20 basis points.
There are no ETFs tracking high-yield or municipal issues.
"Just pick the maturity and exposure you want and own it," says Culloton. "Fit it into the slot you want in your portfolio."
On the equity side, there are many different choices, he adds.
Perhaps the two most popular offerings are Dow Jones Select Dividend Index Fund (DVY), which is an iShares offering, and PowerShares HighYield Dividend Achievers (PEY).
Remember, even though they are relatively high yielding offerings, they can still go down in price and you can ultimately lose money on them.
Launched in December 2004, PowerShares tracks the Mergent Dividend Achievers 50, which ranks the 50 highest-yielding members of the Dividend Achievers. These are stocks that have increased their dividend every year for the past 10 years. "The stocks have the proven ability to generate earnings and cash to support the dividend," Culloton explains.
This criteria alone is a quality screen, he asserts. The fund arranges its holdings by yield and rebalances quarterly.
However, since it is a new fund, there is little track record to go by. Morningstar also is unable to calculate the expense ratio or the current yield.
The Dow Jones fund, launched in 2003, seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Dow Jones Select Dividend Index. The Index is comprised of 100 of the highest dividend-yielding securities (excluding REITs) in the Dow Jones U.S. Total Market Index of roughly 2,200 securities.
"It is more diversified," Culloton asserts.
The two-year old fund initially started with 50 stocks, but in December of 2004 it doubled the number to roughly 100 names. In reality, it contains 92 individual stocks, because the other eight are deemed to be too illiquid.
"They didn't trade often," says Calvin Lee, portfolio manager of US iShares. ""It is more expensive to hold these names." Besides, the remaining 92 stocks have similar characteristics, he adds.
Unlike most index funds, which are market capitalization weighted, the Dow Jones fund, which charges 40 basis points, is dollar-weighted based on the dividend that it pays out, points out Lee.
It balances annually. Lee explains that usually the top 79 names are the same after rebalancing. But, companies fall out after they cut their dividend, such as Fannie Mae. Companies also can fall out of the fund after they are taken over they go out of business.
Culloton points out that more than half of the PowerShares' 50 holdings can be found in the Dow Jones Select Dividend Index. In addition, both funds seem to be concentrated in the same sectors--financial, utilities, and consumer goods stocks.
However, PowerShares includes many utility and small regional bank stocks that don't qualify for the iShares' portfolio.
The iShares fund currently yields 3.7 percent, which seemed like a much better deal when money-market funds were yielding less than 1 percent before the Federal Reserve starting hiking interest rates.
Lee, though, says, "3.7 is not all that bad," but concedes, "it is definitely a concern as interest rates go up."
Stephen Taub is Contributing Editor to BondsOnline. Stephen has been covering financial markets for more than 20 years