A closer look at Fidelity's dividend-based ETFs

Christian Charest: For Morningstar, I'm Christian Charest. Earlier in September, Fidelity became the latest mutual fund company to enter the Canadian ETF world with the launch of six factor-based ETFs that target high-dividend stocks. With me to talk about these new funds is Andrew Clee, vice president of ETFs at Fidelity.

Andrew, thanks for joining us.

Andrew Clee: Thanks, Christian. Happy to be here.

Charest: So, let's start by talking about the three ETFs that have similar names. We have a Canadian High Dividend, U.S. High Dividend and International High Dividend ETF. What's the strategy for these funds?

Clee: So, these are your traditional dividend type paying strategies. So, what you see here is some higher yields. We also see some overweights to the defensive sector, so that'd be utilities, telecoms, real estate. So, generally, what you see over a market cycle is, these do pretty well when interest rates are falling or if you're in a recessionary type period; they tend to lag a little bit when rates are on the move on the upside or bull markets are ripping and roaring. So, what these are: Great sources of income, great diversification and tend to be focused toward higher-quality stocks.

Charest: Now, Fidelity has some ETFs with similar names that have been around in the United States for about two years now. Are these basically the same strategies?

Clee: They leverage a lot of the methodology that we've used down in the U.S. market, but we wanted to fit them for Canadian investors. So, if you think about International Equity Fund, for example, if you take an American lens that includes a big weight in Canadian stocks. So, we actually removed Canada from the investment universe. So, you're getting international exposure ex-North America. If you take a look at the U.S. products down in the States, so focused on the U.S. equity side, they also let those ETFs drift into international markets to enhance the yield. We decided that we wanted pure play exposure. So, 100% U.S. equity. And the reason for that is it fits nicely in a model portfolio. We also didn't want it drifting into the Canadian equity markets.

Charest: So, they are not interchangeable with the U.S. products, but the Canadian versions do have a -- at least for the U.S. product -- they have a currency-hedged version as well?

Clee: Yeah. On the two U.S. equity mandates we do offer currency-neutral versions.

Charest: And what's the track record like? As I mentioned, it's only been about two years but what has the track record been like for these funds in the U.S.?

Clee: Fairly strong. So, we've seen some of the best-in-class returns compared to the peer group. So, what we are trying to do here is really achieve portfolio construction. So, when I look at it, we are offering broad diversification and enhanced yield. So, down in the States, we have some pretty attractive yields and some pretty attractive relative returns compared to the dividend category.

Charest: ETFs that target high dividends have been very popular in Canada. So, you will have a lot of competition on that front here. What sets these funds apart from the well-established players?

Clee: Well, I think, if you think about how the industry has evolved over the last, let's call it, 10, 12 years, we saw the introduction of smart beta factor ETFs and a lot of it was focused on screening criteria, so how do we identify the stocks. I think we've taken a little bit of our fundamental insights from the active portfolio management side of the business and put a lot of focus on the portfolio construction aspect. So, in terms of what sets us apart. I think we've done some interesting techniques to create broader diversification and less concentration risk from the portfolio construction angle. So if I was to put it in few words if you think about it there's really three sources of risk. The first being market cap risk. Second being sector concentration risk and then third being company bet-size, so relative overweight to others. And I think we’ve done some interesting things to eliminate some of those biases that might be found in some of the older ETFs.

Charest: Now another mandate that was launched this month that sounds very intriguing is called Fidelity U.S. Dividend for Rising Rates Index, and according to your factsheet it seeks exposure to U.S. dividend-paying companies that are positively correlated to rising interest rates. How is it going to do that?

Clee: So, if you think about my previous comments. Dividend type strategies tend to underperform in rising rates environments and why is that, it is that defensive sectors tend to be a little bit interest-rate sensitive, so that’s utilities, telecom, real estate. What we do here is we actually sector-neutralize it back to the broad universe. So, you don’t have as large an overweight on utilities, telecoms and real estate. A second factor that we use in the screening criteria is correlation to 10-year Treasury yield. So, what we are trying to do is identify stocks that perform better within each sector when the yield curve is rising. So that combination has actually created a pretty interesting mix where we created a dividend strategy that has an enhanced yield -- you do need to sacrifice a bit of yield relative to the high-dividend products. But we’ve also created a performance mix that can perform very strongly in bull markets as well as rising rate environment through our back tests.

Charest: Now Fidelity mutual funds in Canada are typically sold through financial advisors. What's the distribution strategy going to be for the ETFs now.

Clee: So, I'm sure if you've noticed we've always believed in the value of advice. But by going direct to ETFs you are available on the Toronto Stock Exchange. So, a lot of the uptick we've seen in the last five trading days has been from the financial advisor community. But you can also buy it on the discount brokerages. A second thing that we did was we launched mutual fund versions of the ETF. So, at Fidelity we just view them as wrappers whether it's an ETF or a mutual fund, and we're just trying to deliver investment expertise. So mutual fund or ETF, we're kind of indifferent. We just want to get these products out to the broad market.

Charest: And they are available both in versions that pay trailer fees to advisors and in F Class versions as well.

Clee: That’s correct Series B is our trailer version and Series F is the fee-based.

Charest: Fidelity already offers several other factor ETFs in the United States that target factors such as value, momentum, low volatility. Are there any plans to bring any of those strategies to Canada?

Clee: So I think we are constantly evaluating the market. I would love to tell you that we're coming up with this one in January, this one in April. But what we've decided is we have a lot of fundamental insights from our portfolio managers and we want to be opportunistic with fund launches. So, if you think about rising rates, that’s meeting a client need of today. So, we talk a little bit with our active portfolio manager and say what's the problem? We need income, but we need something that can weather the storm of rising rate environment. So that is how the rising rate strategy was born. So, I think going forward we'll be opportunistic based on the market environments.

Charest: Andrew, thank you very much for sharing all this with us today.

Clee: Thanks Christian.

Charest: From Morningstar I'm Christian Charest. Thank you for watching.