Today, we look at a hedged ETF, a BMO dividend fund that Pat McKeough was asked to evaluate by a Member of his Inner Circle. The BMO US Dividend Hedged to CAD ETF holds stocks that are attractive on the surface: U.S. companies that have raised their dividends over the past 3 years. However, the need to hedge against movement of foreign currencies forces the fund to rebalance its holdings each year, which leads to ongoing brokerage charges and often, the necessity of selling rising stocks.

For our view on the most effective way to profit with ETFs, read: When you invest in ETFs, keep it simple. We explain why hedged ETFs typically generate higher fees for the sponsoring firm but greater risk for investors.

For a recent article on two ETFs that we do like, read Two Vanguard ETFs provide low-cost way to diversify beyond Canada.

BMO US Dividend Hedged to CAD ETF, (symbol ZUD on Toronto; www.etfs.bmo.com) holds U.S. stocks that have maintained or increased their dividend rates over the last three years and meet other criteria, including yield and dividend payout ratio. The fund’s managers rebalance the underlying portfolio in June and December.

Top holdings are Philip Morris International, ONEOK Inc., Garmin, Noble Corp., Verizon Communications, Mattel, Williams Cos., Gamestop, McDonald’s and Darden Restaurants.

The ETF is hedged against movements of foreign currencies against the Canadian dollar. Its value rises and falls solely with the stocks in its portfolio, so it wouldn’t give you any diversification through foreign currency exposure.

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BMO dividend fund: Fixed rules force this ETF to sell sound stocks that have temporary setbacks and cut their dividends

Dividends are typically a sign of investment quality. Some good companies reinvest their profits instead of paying dividends, but fraudulent and failing companies are hardly ever dividend-paying stocks. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all of the market’s worst stocks.

However, this particular ETF incurs ongoing brokerage charges each year as it rebalances its holdings. As well, its adherence to fixed rules forces it to sell sound stocks that have experienced only temporary setbacks and cut their dividends. It also forces the fund to sell off securities that are steadily rising—which in turn lowers their yields—perhaps missing out on some of their biggest gains.

This ETF has a 3.1% yield. Its MER is 0.34%.

We don’t recommend the BMO US Dividend Hedged to CAD ETF. 

Inner Circle recommendation: SELL