Would you like to invest in a product that pays a 10% dividend yield and is built on banks and other blue chips?
This is what Dividend 15 Split Corp (DFN.TO) offers: a group of 15 companies where you can hold Class A and preferred shares. When I looked at the list of the 15 companies, I understood it was a select group: Bank of Montreal (BMO.TO), National Bank of Canada (NA.TO), Sun Life Financial (SFL.TO), Bank of Nova Scotia (BNS.TO), CI Financial Corp. (CIX.TO), TELUS Corporation (T.TO), CIBC (CM.TO), BCE Inc. (BCE.TO), Thomson Reuters Corporation (TRI.TO), Royal Bank (RY.TO), Manulife Financial (MFC.TO), TransAlta Corporation (TA.TO), Toronto-Dominion Bank (TD.TO), Enbridge Inc. (ENB.TO) and TransCanada Corp (TRP.TO). The list is pretty solid and the yield is even better, so… what could be wrong with split corps?
Never Trust a Broker
If a broker wants to sell you something, it’s probably because it’s really good… for his pocket! This is the case with most structured products. As you have probably figured out by now; an investor holding those 15 companies in his portfolio would not come to a 10% yield. The Dividend 15 Split Corp is able to generate such high yield because it is a structured product; a clever mix of shares and options that produce high returns… for the brokers. These products show lots of smoke to the investors but are built to generate generous commissions to any broker selling them. This is why these products make it on the market anyway.
As the company’s portfolio doesn’t generate enough to pay a 10% yield and cover the firm’s management fees, the remaining cash has to be found elsewhere. Since this portfolio would generate around 5% dividend yield, the mutual fund company (yes, DFN is in fact a mutual fund company) trades the underlying securities and writes call options on them too. These operations also trigger additional costs to the investors as even performance bonuses for traders are included in the “creation of wealth process”.
Okay, this doesn’t look that good… but what about the 10% yield???
When I hear about something that is too good to be true, I always check its return over the past 10 years. So here’s what the DFN.TO graph looks like:
As you can see; lots of fluctuation and a loss of 8.50% in value over 10 years. I guess the good news is the 10% dividend yield remained during the whole period. Still, during the same period, the Canadian market grew by 60% excluding the dividend (if you held Canadian banks for the past 10 years, I don’t have to convince you made a lot more than the Split Corp).
So the structure is not the best thing for an investor and the return is not impressive… are you still going to argue with the 10% yield? All right, check out what happened when things turn sour. Here’s another split share corp that was very popular prior to 2008:
This is the chart of the US Financial 15 split corp (FTU.TO). The stock lost almost everything while US banks took a hit but bounced back. Why FTU wasn’t able to get back on track like the underlying stocks? Because the firm was too busy trading the stocks and writing options that they completely lost the investors’ capital.
So Are Split Corps a Good Investment?
For any type of investments (stocks, ETFs, structured products or funds), I always rely on my 7 investing principles I follow to succeed. The first one is “high yield doesn’t equal high returns” and the third one is “A dividend payment today is good, a dividend guaranteed for the next ten years is better”. Using these two principles; I’d tell you that a split corps would never be part of my portfolio. But if you don’t like my investing principles, you can also argue with the most prolific investor of all time, Warren Buffett who once said:
Never invest in a company you don’t understand.
If you think you understand how traders write their call options and trade those stocks to make money for you (and not for them), good… I don’t! What I understand is only how they make those trades to generate fees for the firm…
How would the peformance of DFN compare to the market if you look at ‘Total Return’ with dividends reinvested?
See http://media.wix.com/ugd/78f11d_60591fe033fa4815bf59e8a5746a155f.pdf
Specifically, pg. 8
With an initial investment of $10k, if you compare the 10 year total return (including dividends) of DFN vs the TSX, you would have approximately:
DFN: $27,000
TSX: $21,000
Source: Morningstar (http://quote.morningstar.ca/Quicktakes/stock/perf.aspx?t=DFN®ion=CAN&culture=en-CA&ops=clear)
Add TSX using the Comparison tool.
DFN is not designed for capital gains but to provide a steady monthly source of income.
Good analysis mike. I don’t understand how they do it so I’ll stay away from it but that 10% yield is quite the eye catcher with those holdings! There’s definitely more to it than just plain dividends paid out! Thanks for going deep into DFN.TO
Ian, Arneh,
It would be interesting to do the comparison with XDV instead of the TSX. I should have used XDV in the first place!
I’m pretty convinced XDV had done a much better job, don’t you think?
Hi DivGuy,
I agree that XDV Total Return definitely has better performance than the TSX Total Return.
However, if you add XDV using the Morningstar comparison tool above, it still under performs DFN with dividends reinvested:
DFN: $27,000
XDV: $24,000
XDV is inherently less volatile though, which should help its performance when the market is going through a rough patch.
If the concern is whether DFN can continue making payments at 10%, just keep in mind that they not have missed a single payment since inception in 2004 (including the financial crisis in 2008).
I had never heard of a Split Share Corporation before. Interesting idea, but I can’t say I would be that interested in investing in these types of funds based on the need for options to juice the yield.
An ETF like SDY (High Yield Dividend Aristocrats), cut its distribution during the last finanical. Any fund using some additional strategy for gains would only increase the chances of a lose.
Dividends are important to me, but I don’t want to loose capital permanently.
DivGuy,
I am with you all the way with not trusting a broker. If I am going to fail, I would rather do it on my own. It seems the brokers that I have met had nicer homes and better cars than I do. So, they must be making a fortune off of the clients.
Nice article.
Keep cranking,
Robert the DividendDreamer
Hello Robert,
well, I can tell you this; successful brokers make lots of money (I used to do banking for them 😉 ) and unsuccessful brokers… well… they don’t stay in the business! hahaha!
I actually held DFN for a little while when I first started investing and was looking only for yield. Then went onto dividend growers and cut it out.
Imagine a pot of 1 million shares. 500k of those shares are low interest and guaranteed. The excess earnings from those 500k shares go into the higher risk pot of 500k shares. That’s how you juice the returns. In addition there’s a moderation built in due to options trading.
It’s not the capitol return or dividends that make you money. It’s the compound interest over time. It’s slow in the beginning but snowballs in the end.
This article does not at all address the essential feature of split share companies: the preferred shares that get first dibs on a five percent yield but no capital gains, and the capital shares that get all the remaining dividends plus all capital gains.
The preferred side of investment grade splits in my opinion are great for steady income. Investment grade split preferreds have not lost money in any of the last 6 years even when the preferred space was getting bloodied in 2015. I spent a ton of time looking at this space .