Money Smarts: Three ETFs For Income Investors

These three low-cost funds offer good diversification and steady cash flow.

Until the past few years, investors rarely thought of exchange-traded funds (ETFs) as an income source. Most people saw them as a stock proxy, deigned to generate capital gains as the market moved higher.

But all that has changed. Almost every ETF provider now offers a range of income-oriented funds, with more appearing all the time. In the first quarter of this year, we saw the launch of over a dozen new income ETFs including the BMO Canadian High Dividend Covered Call ETF (TSX: ZWC) and BMO U.S. Put Write Hedged to CAD ETF (TSX: ZPH).

These ETFs look interesting from a cash flow perspective. ZPH is currently yielding 6.7 per cent, based on its monthly payouts since February, while ZWC is yielding 6.2 per cent. However, both funds have been quite volatile so far, which will not sit well with conservative investors.

When I select ETFs for readers of my Income Investor newsletter, I look for those with a sustainable payout stream and relatively low volatility. Income investors tend to be older and are more interested in cash flow and stability than in capital gains.

Here are three that I like right now. Prices are as of the afternoon of July 27.

Horizons Active Preferred Share ETF (TSX: HPR)

Current price: $9.46
Annual payout: $0.3734 (trailing 12 months)
Yield: 3.9 per cent.
Risk: Higher risk
Website: www.horizonsetfs.com/ETF/HPR

Comments: This is one of the few actively managed preferred share ETFs in Canada (Horizons also has an actively-managed Floating Rate ETF while Dynamic iShares recently launched a new one).

At the time I recommended it in The Income Investor, I said it offered good cash flow but warned that we could see a pullback in the share price if interest rates moved higher. In fact we saw a dip in the price after the units touched a 52-week high of $9.50 in early April, but they have rallied since, and were trading at $9.46 at the time of writing.

The portfolio is well diversified, and 95 per cent of the assets are rated P-3 or higher. The management fee is 0.55 per cent.

Summary: This ETF continues to be a good choice for investors who want some preferred share exposure.

BMO Equal Weight Utilities Index ETF (TSX: ZUT)

Current price: $17.89
Annual payout: $0.678 (trailing 12 months)
Yield: 3.8 per cent
Risk: Moderate
Website: www.etfs.bmo.com

Comments: This fund has been in a bit of a slump recently, reflecting weakness in the interest-sensitive utilities sector in face of rising rates. I see that as a buying opportunity.

The portfolio consists of most of the top utility companies in Canada, including Algonquin Power and Utility (TSX: AQN), Fortis (TSX: FTS), and Emera (TSX: EMA). Also near the top of the list in terms of weighting are two Bermuda-based limited partnerships that I have been recommending for years: Brookfield Renewable Partners (TSX: BEP.UN) and Brookfield Infrastructure LP (TSX: BIP.UN).

Distributions are paid monthly and are currently running at the rate of $0.056 per unit. Most of the payment is taxed as dividend income, with a small amount designated as return of capital. This tax advantage makes the units very appropriate for non-registered accounts.

Summary: Despite the interest sensitivity, this fund is still suitable for risk-averse income investors.

BMO International Dividend ETF (TSX: ZDI)

Current price: $22.14
Annual payout: $0.96
Yield: 4.3 per cent
Risk: Higher risk
Website: www.etfs.bmo.com

Comments: This ETF invests in a yield-weighted portfolio of dividend-paying stocks issued by companies in developed nations outside North America. Stocks are screened using such metrics as dividend growth history, payout ratio, and liquidity.

This ETF has done well since the start of the year, moving up more than $2 since January. For the year to June 30, it gained 24.8 per cent, although it showed some weakness recently as a result of the shift by the Bank of Canada to a more hawkish approach.

Somewhat surprisingly, given its political and economic turmoil, the U.K. holds the number-one position in geographic allocation, at 21.1 per cent of the overall portfolio. Australia is number two at 16.4 per cent followed by France (12.9 per cent), Spain (8.4 per cent), and Sweden (7.6 per cent).

Distributions are paid monthly at the current rate of $0.08 per unit. Most of the payments are fully taxable, so this ETF is best held in a registered plan.

The management expense ratio is 0.44 per cent, and the fund has $233.6 million in assets under management.

Summary: Keep an eye on this one. I see the recent price pullback as a buying opportunity, although we may see more downside before the interest-rate picture becomes clearer.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.