US Equity | Telecom Services

Michael Johnston

Stock quotes in this article:

ist

As the ETF industry has evolved over the past few years, the capabilities of these vehicles have expanded dramatically. It wasn’t very long ago that ETFs primarily represented broad stock markets or fixed income benchmarks. Now, they are used to deliver access to increasingly complex asset classes and investment strategies. One example of such innovation — and one that has seen tremendous growth — is the dividend-ETF corner of the market.

Dividend-focused funds are often handy tools for tapping into a basket of stable companies that make stable distributions. But they’re not always the most efficient way to capture a meaty dividend yield. For that objective, it’s often the more antiquated and simpler sector ETFs that can more efficiently deliver yield. One fund that I’ve been watching recently delivers a hefty slice of current income the old-fashioned way: focusing on a sector that targets an industry with a tendency to make elevated payouts.

The SPDR S&P International Telecom ETF (IST ) has had a pretty rough start to 2012. It’s lost more than 10% of its value on the year, thanks in no small part to a hefty weighting to struggling European economies. But, even with the rapid decline in value, expected dividends from component companies have remained reasonably stable. The result: a dividend yield on the underlying index that now exceeds 7%. That’s more than triple the yield vs. many broad-based equity funds, and substantially higher than what some dividend-focused funds are offering up right now.

IST isn’t without its risks. As mentioned above, it has big allocations to several of the trouble zones of Europe. If the eurozone continues to struggle, IST could experience more tough times ahead. But the portfolio generally comprises stable mega-cap stocks that have been making distributions to shareholders for decades. While they may be forced to reduce their payouts a bit, it’s hard to imagine material reductions ahead. Telecom is a relatively safe sector, and the companies that make up IST maintain relatively healthy profit margins and moderate growth potential.

The opportunity to capture a 7% yield from these types of securities is therefore rather appealing, especially at a time when rates are expected to be depressed for the foreseeable futures.

As a side benefit, IST has the potential to bring some nice diversification to portfolios. The beta of just 0.36 indicates a relatively low correlation with broad U.S. equity markets — a rarity for an environment in which correlations have seemingly shot toward 1.0.

One word of caution on this ETF: It’s relatively small, and it doesn’t trade all that frequently. That certainly doesn’t mean you should stay away, but it does highlight the importance of using limit orders at all times here.

At the time of publication, Johnston had no positions in the stocks mentioned.