Global interest rates are at record lows. The lowest the world has seen. The US Federal Reserve however, is gearing up to raise interest rates 3 or 4 times this year. Don’t be fooled. Even with these rate hikes, interest rates will still be historically low. Australian rates on the other hand, will remain near historical lows for years, with inflation unlikely to hit 2% until the end of 2019 at least. That’s quite a conundrum for yield dependent investors who will  have no other choice but to look else where for returns in excess of the measly couple of percent they can get on their bank deposits. Retirees in particular have done it tough. A large bulk of their savings are in interest bearing assets. You can understand why they feel hard done by. With interest rates so low, retirees take on more risk by chasing higher returns. Rather than doing proper research and searching for quality investments, some retirees have pursued a less desirable alternative: High Yielding ETFs. The low interest rate world has led to a new breed of investments devised to solve the yield problem. These instruments attempt to give yield dependent investors the high yield they’re so desperately seeking. But it all comes at a hefty cost. These investments are called High Yield Exchange Traded Funds. Firstly what are High Yielding ETFs? They are exchange traded funds listed on the ASX. Billed as simple to use and cost-effective instrument, these securities allow investors to implement an equity income investment strategy over a portfolio of 20 blue-chip Australian shares. The ETF peddlers highlight their ‘attractive income’ as their key quality. And they’re right. These High Yielding ETFs are capable of earning quarterly income (including franking credits) that exceeds the dividend yield of its underlying share portfolio over the medium term. For this article we’ll used the Betashares Equity Yield Mazimiser Fund (YMAX) or the BetaShares Australian Dividend Harvester Fund (HVST) as an example. YMAX has a 12 month distribution yield of 8.5% which grossed up is 10.30% and has 49.8% franking. That yield is exceptionally high and very attractive but here’s the catch. What the ETF peddlers don’t tell you is that all that is gained on the distribution yield is given back in capital losses. The Harvester uses a ‘dividend harvest’ strategy. What that means is that it buys shares that are about to payout a high dividend, such as a bank or infrastructure company. The sad truth is when buying pre dividend shares are usually higher. When selling ex dividend, shares will have already fallen by the dividend amount. This results in a capital fall every time it is done. You can see it in the funds performance. Both the YMAX and HVST are carrying huge capital losses since inception. This makes the attractive distribution claim a little bit of a con. At inception, 29 October 2014, the HVST Fund NAV was $24.86. Today it is trading at a NAV of $16.00. That’s a 36% loss since inception. The fund lost 17.90% in the year to the 31 January whilst it paid out a distribution yield of 11.40%. So in effect the fund actually lost you 6.50%. The fund seems to have a hedging strategy in place to minimize downside volatility. However the hedging doesn’t seem to be working with the fund still amassing huge losses. However the fund does have some appeal to retirees. It pays its high dividend monthly and straight into your bank account at the middle of every month. Therefore living off dividends makes it very easy. But the only drawback is the harvesting strategy in a bull market. Using the dividend harvesting technique results in less upside when markets are going up. But what we’ve also noticed, is that the HVST fund also fell during downturns in the ASX 200. That makes us somewhat question the firm’s risk management strategy.  Don’t fall in the trap The bottom line is that the HVST fund is a dividend trap, it delivers income at the expense of capital growth. The fund basically pays you back part of your capital with every distribution, until they’ll be nothing left. Whilst the fund publishes its distribution as 11.40%, it’s really -6.50%. As mentioned above, one of the reasons for the capital loss is buying cum dividend shares…

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