Will ETFs reinvest dividends for you?
Just as when you invest in a regular mutual fund, if you’re looking to put money in an exchange-traded fund (ETF) it’s also important to choose the right share class.
An increasing number of ETFs, certainly those from big providers like iShares and Vanguard, will have either accumulating (acc) or income (inc) share classes, and the right one to pick depends on your investment objective.
PICK THE RIGHT ONE
ETFs with accumulating share classes will reinvest dividends back into the fund, usually at no extra expense, while income share classes will fund a dividend from the payouts the ETF has garnered from its underlying holdings (e.g. a FTSE 100 ETF paying out the money it received in dividends from the likes of Royal Dutch Shell (RDSB) or GlaxoSmithKline (GSK)).
Different classes of ETF will have different tickers or EPIC codes. For example iShares Core S&P 500 (CSPX) accumulates income while the iShares Core S&P 500 (GSPX) distributes.
Remember to check the share class when looking at the performance of an ETF, as the acc share class will appear like it’s performing better than the inc one, because the dividends being reinvested will compound returns.
If you’re looking for growth from your investments and don’t need an income, the acc share class is best while the inc share class is better for those seeking an income.
The income share class could also be called a distributing (dist) share class, which is effectively the same thing.
YOU WON’T ALWAYS HAVE A CHOICE
For some ETFs you may only be able to get one or the other.
For example, the popular SPDR S&P UK Dividend Aristocrats (UKDV), used by many ETF investors looking for an income, doesn’t have an acc share class.
In addition a majority of bond ETFs, by design, tend not to have acc share classes as ETFs in general tend to behave like their underlying holdings.
So when the coupon, i.e. the annual interest payment, is paid on a bond the ETF will distribute the payment to its investors.
On the flip side there are areas of stock market investing where dividends will be low or non-existent so you’ll only be able to find an accumulating share class.
For example a lot of technology ETFs will only have an accumulating share class because the underlying holdings will either pay a tiny dividend or none at all.
Most companies in the tech sector are in growth mode so they’ll tend to funnel earnings back into the business to fund more growth, safe in the knowledge that shareholders accept it as part of the investment story.
ETF providers offering both share classes is a relatively new phenomenon in the UK, with Vanguard last year rolling out acc share classes on most of its range.
The year before, iShares even listed acc share classes to its European and Asian property ETFs.
Real estate is particularly popular with income-seeking investors, given that real estate investment trusts (REITs) – which feature heavily in the indices most property ETFs track – are required to distribute 90% of their taxable income to investors in the form of dividends.
GIVING INVESTORS WHAT THEY WANT
AJ Bell head of passive portfolios, Matt Brennan, says the main reason ETF providers now offer both share classes is because that’s what investors want.
He explains: ‘Historically if you received cash from the ETF you had to pay dealing charges every time you reinvested.
‘If you invested in a FTSE 100 ETF for example and got a 4% to 5% yield, over two years you could end up with 10% cash and that may not have been what you’re trying to achieve.’
While investor demand led to more acc share classes being available, it’s also something ETF providers see opportunity in, says Brennan.
He adds: ‘There’s a decent commercial angle for providers. With the acc share class, the provider reinvests dividends for investors and so they capture the opportunity by keeping people invested in the ETF for longer.’
While most big providers offer both share classes in their ETFs, Brennan adds that some of the smaller or more niche providers may still only offer either accumulating or income share classes.