Two ETF portfolios for income: one year on

Between February 2015 and February 2016 equities hit a peak followed by a dramatic decline, but our two portfolios proved resilient against the steep falls across global markets.

Both portfolios have paid out income during that period and have held up better than broad equity indices in capital return terms. Mr Miller's portfolio has lost 2.6 per cent as a whole, but currently offers a yield of 2.7 per cent. Mr Taylor's portfolio has fallen further, losing 4.3 per cent, but is trading on a higher yield than the FTSE 100 at 4.2 per cent. That is impressive against falls of 6.8 per cent for the FTSE 100, 4.9 per cent for the FTSE All-Share and 4.9 per cent for MSCI Europe, particularly as those indices have a lower yield. Without the real-estate investment trust Mr Taylor included in his portfolio, however, it would have suffered further losses.

Capital growth

The best-performing ETF by far in capital growth terms is one of Mr Miller's choices - WisdomTree Europe Small Cap Dividend UCITS ETF (DFE), which returned 8.44 per cent between 1 February 2015 and 1 February 2016. It was the best performer when we last checked in with the portfolio in June 2015 and has outperformed the majority of funds, which shed value during that period. WisdomTree has both an income and capital growth strategy. It aims to isolate dividend-paying smaller companies in Europe that have the most chance of offering growing and sustainable yields. It does that by focusing on annual cash dividends paid rather than looking at yields, which can be a sign of an unsustainable payout and reflect a falling share price rather than high income.

The ETF returned 17.2 per cent in 2015 and is also yielding a healthy 2.99 per cent at the moment. It includes shares such as Belgian real estate company Cofinimmo (COFB:BRU) and Swiss financial services provider Cembra Money Bank (CMBN:SWX).

Two of Mr Miller's other choices returned positive results during the period analysed. iShares Core Japan IMI UCITS ETF (SJPA) returned 5.9 per cent, and iShares £ Corporate Bond 1-5yr (IS15) and iShares JPMorgan $ Emerging Markets Bond UCITS ETF (IEMB) returned good capital growth.

Japan should be an interesting region to follow this year after the country's central bank moved to negative interest rates in a surprise cut last month. The benchmark rate of -0.1 per cent means that the Bank of Japan will now charge commercial banks for some deposits and this is likely to significantly weaken the yen. The move is a step by the government to drive spending and it already has boosted equities, which tanked earlier in the year following the Chinese stock market crash.

Although this move is likely to prove beneficial for equities, a weakening yen could detract from the returns of unhedged ETFs such as this one in the coming year. Playing currencies is a difficult game, though, as evidenced in Mr Taylor's decision to add iShares MSCI World GBP Hedged (IGWD). The unhedged version did better over the time period analysed, showing that paying for the cost of hedging is not a good idea unless you have a very strong conviction on currencies.

Best income ETFs

Neither of our experts stuck purely to distributing share classes, with Mr Miller favouring a strategy of taking income both from distributing share classes and profits on growth. When it comes to income paid, the fund on the highest current yield by far is iShares UK Dividend UCITS ETF (IUKD), which offers diversified exposure to the 50 companies making up the highest yielding subset of the FTSE 350.

The ETF has a dividend yield of 6 per cent, but that could in part be due to looming concerns over the sustainability of dividends from UK companies. Its share price dropped by 6.7 per cent between February 2015 and February 2016, but Mr Taylor still likes the ETF.

"The iShares UK Dividend ETF has been the worst performer, but no surprises there because it has such high exposure to the energy and mining sectors," he says. "BP (BP.) and Shell (RDSA) are in its top 10 holdings and the dividend cover on those may not be sustainable. But over the long term I think this ETF should, even on a reduced dividend yield, give a better income than the alternatives.

"Even if BHP Billiton (BLT), currently on a 13 per cent yield and down 56 per cent in share price value on last year, cut its dividend by half that would still be a better yield than you could get elsewhere. With rates not likely to get above 1 per cent for the foreseeable future and gilt yields at such low levels, we should expect dividends of more than 5, 6 or 7 per cent."

In the time period analysed iShares UK Dividend ETF, which pays quarterly dividends, has paid out £2.61 based on an initial investment of £50, making it the highest income payer in Mr Taylor's portfolio. To analyse the theoretical income earned for each ETF we assumed the same level of initial investment as its percentage weighting in the portfolio - ie a 50 per cent weighting is equal to a £50 investment.

But even if the initial investment had been invested in each ETF (£100 in each), iShares UK Dividend UCITS ETF would still be the highest income payer, distributing £5.21 between February 2015 and 2016. iShares £ Corporate Bond ex-Financials UCITS ETF (ISXF) would have paid £3.62 and iShares £ Index-Linked Gilts UCITS ETF (INXG) would have paid out £1.80.

Although Mr Miller's portfolio has a greater number of high-yielding ETFs than Mr Taylor's, the relative weightings of the small initial investments and the time period taken, mean that his portfolio has paid out a lower income overall. His best income-paying ETF has been iShares JPMorgan $ Emerging Markets Bond UCITS ETF, which has a yield of 5.3 per cent and paid out 22p in the period, and PowerShares RAFI US 1000 ETF (PSRF), which paid out 25p.

But iShares JPMorgan $ Emerging Markets Bond UCITS ETF is still the best earner when all ETFs are compared on an investment of £100. Mr Miller added the ETF to his portfolio in June 2015 because it had a higher yield to maturity than the fund it replaced - iShares $ Emerging Market Corporate Bond ETF (EMCR). iShares JPMorgan $ Emerging Markets Bond's distribution yield was also almost double that of iShares $ Emerging Market Corporate Bond ETF, so that looks to have been a good switch in income terms: it would have paid out £4.45 on an initial investment of £100. It has also held up well against market losses, returning 3.75 per cent over the period analysed. This ETF also pays income monthly.

PowerShares RAFI US 1000 Portfolio tracks the performance of large US equities, but attempts to filter out overvalued stocks by homing in on company size, book value, cash flow, sales and dividends. The FTSE RAFI US 1000 Index fact sheet says: "The indices are less prone to excessive concentration arising from market fads, which can result in overexposure to individual companies, sectors or countries."

The ETF has not fallen in value over one year but its return of 0.01 per cent has not beaten the S&P 500's 3.1 per cent, and its income has been moderate. 

Portfolio changes

Mr Taylor is not keen to make major changes to his portfolio and is holding on to the ETFs that have performed least well over the year. He does, however, want to introduce exposure to the FTSE 250 via iShares FTSE 250 UCITS ETF (MIDD). The FTSE 250 has dramatically outperformed the FTSE 100 over the past decade: in 10 years it has returned 127.5 per cent compared with 46.2 per cent for the FTSE 100 and Mr Taylor sees it as a good holding for moderate investors due to its lower concentration of risky stocks.

"At the moment we think the FTSE 250 is a better option tbecause of the preponderance of oil and mining stocks in the FTSE 100," he says. "The FTSE 250 still has a yield of 2.97 per cent and is more likely to be stable over the long term."

As a result, Mr Taylor has reduced iShares UK Dividend UCITS ETF to half its former position and invested 25 per cent of the portfolio in iShares FTSE 250 UCITS ETF.

Mr Miller says he wants to move away from themes that have outperformed this year but which he thinks might have now run their course. Those are emerging market small-caps and the strength of the dollar.

He says: "Emerging markets have gone down a lot, but I have been in emerging market small-caps which have massively outperformed large-caps - although it would have been better not to have any emerging markets exposure at all. I would now reduce that small-cap emerging market exposure by half and put that into iShares Core Emerging Markets IMI UCITS ETF (EIMI), which is a fantastic fund. I think the outperformance of small-caps against large, which has been a common feature across the world, is gradually running out of steam, so I would reduce that weighting to 5 per cent and add 5 per cent to EIMI.

Mr Miller is also keen to move out of one of his most successful income ETFs during this period and one of the only positive contributors to total return - iShares JPMorgan $ Emerging Markets Bond - due to his belief that the dollar will not continue to strengthen.

"I think the dollar has come to the end of its run so I would sell dollar-denominated emerging market debt and reinvest it in iShares Global High Yield Corporate Bond GBP Hedged UCITS ETF (GHYS)," he says.

"I think this ETF has a better risk-return ratio now. Because this is a global high yield ETF it includes European as well as US high-yield investments, and Europe has less exposure to oil and gas. So you get the extra diversification, 1,036 holdings and a yield to maturity of over 7 per cent."

Alan Miller's original portfolio, performance and income

Source: FE Analytics, Investors Chronicle

Alan Miller's adjusted portfolio

Source: FE Analytics, Investors Chronicle

Paul Tayor's original portfolio, performance and income

*Total return figure from launch - 18 March 2015

Source: Returns from Trustnet, yield figures from Bloomberg Datastream

Paul Taylor's adjusted portfolio

Source: FE Analytics, Investors Chronicle

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