Exchange Traded Funds offer the investor a way to reduce stock-specific risk. ETFs are also traded to make money on market outperformance. In this grim environment, we can go one step further with ETFs by playing dividend hopscotch.
Dividend hopscotch is designed as a trading method to skim, or lift, the dividends payable on all the stocks that make up the underlying index. In a rising market it delivers a capital return and a dividend return. In a falling market the risk is greater because the strategy may incur a capital loss.
Initiation of the strategy will depend on the direction and nature of the trend prior to the entry and exit point. The ideal situation is a rising trend or at worst, a sideways trend. This ensures that the risk to capital is reduced, and the dividend yield is captured completely.
The objective is to simply take the dividend. In some countries, for example Australia, this method is subjected to an additional level of taxation if the stock is not held for a specified lock-up period.
Dividend hopscotch creates a calendar spread using the trading of international listed ETFs. This is dividend hopping, moving from one dividend payment period to another. The objective is to reap an income return, rather than a capital return.
Implementation of the strategy starts with an assessment of the dividend yield that applies to each of the ETFs This is most difficult in period 1, period 3 and period 5, as there are 14 international ETFs that go ex-dividend near the same date. The objective is to identify the ETF with the highest dividend yield. This type of information is aggregated by www.ishares.com and independent providers such as www.XTF.com.
Let's assume that the Hang Seng Index ETF trades under the symbol IHK. IHK has the highest dividend yield for the period 1. It also has the best trend behavior and meets the conditions for entry that we would apply if we were trading a single ETF for a capital gain. The trade is entered and exited outside of the minimum required holding period. It captures capital gain and a dividend bonus.
Moving out of December we go to the next ETF dividend period in March. This applies to the ETFs covering the U.S. market. Of these, in this example, the IRU ETF which covers the Russell 2000 Index has the best dividend yield and trading characteristics. This dividend trading strategy 'hops' to the next most profitable ETF from a dividend yield perspective.
In the third period the trade hops to the StreetTracks ETF, STW which covers the Australian market. The fourth period sees a hop to IVV which captures the dividend return from the S&P 500. The fifth period hops to the dividend yield from Japan.
Each trade captures the ETF price activity and capital gain, and the dividend yield from the most successful individual ETF. The ETF strategy objective is to use the ETF to obtain alpha performance. The ETF provides a low risk and steady reward model for investment. The risk is the same as the market risk. The reward is also the same as the market and after the volatility of 2008, many investors will look on this as a favorable combination in 2009. This is one of 21 ETF trading strategies we apply to maximize ETF returns.
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