COMMENT
Get High Yield At Low Cost

By David Kuo (TMFDragon)
November 2, 2005

You may remember an article written about a year ago by my colleague Maynard Paton. At the time, he was calling for a high yield tracker, and it seems that his wish has finally been granted.

Barclays Global Investor has said that it will launch iShares FTSE UK Dividend Plus. The Exchange Traded Fund, which is expected to debut this week, is designed to track the 50 highest yielding shares in the FTSE 350 index and its annual charge will be very low, at just 0.4%. But just how good will it be?

Interestingly, the ETF will use fundamental indexing. What this means is that the constituents of the fund will be weighted not by market capitalisation, but by another measure. In this case, it will use the one-year forecasted dividend yield. As with most other FTSE indices, its constituents will be recalculated every three months.

According to the iShares fact sheet, the top half dozen constituents of the fund will initially be weighted as follows:

Company	Sector	Weighting
United Utilities (LSE: UU.)	Utilities	3.78%
GCAP Media (LSE: GCAP)	Media	2.97%
Electrocomponents (LSE: ECM)	Industrial	2.87%
Corus Group (LSE: CS.)	Basic Resources	2.70%
Lloyds TSB Group (LSE: LLOY)	Banks	2.66%
Amlin (LSE: AML)	Insurance	2.63%

It has been argued by some that fundamental indexing may in fact be a better form of equity weighting. That's because weighting by market capitalisation has a tendency to skew your holdings towards over-valued companies at the expense of undervalued businesses. Fundamental indexing should go some way to rectify this shortcoming. However, there is a sting in the tail.

By using yield as a yardstick, smaller companies may carry a higher weighting even though their dividend yields may be less certain. For instance, shares in a company may have fallen because of concerns over its ability to maintain a generous dividend payout, even though forecasts are indicating that its dividend will be maintained. Consequently, a share's yield will be boosted because yield is a function of the dividend and the share price.

Backtesting by iShares indicated that the FTSE UK Dividend Plus index would have significantly outperformed the FTSE 350 High Yield index in recent times. Since the start of 2000, it would have returned 132%, outrunning the FTSE 350 High Yield index's performance of 49%. It has even outperformed TMFPyad's original High Yield Portfolio, which has returned around 50% since November 2000. Over the equivalent period, the FTSE UK Dividend Plus index would have returned around 90%.

On balance, I believe that iShares FTSE UK Dividend Plus is a welcome addition to the growing choice of ETFs. However, I remain a little concerned about the way it allocates its fund weighting, so cautious yield hunters may want to consider running it alongside another income investing strategy.

David owns shares in iShares FTSE 100.

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