Is the Vanguard Australian Shares High Yield ETF a good investment for dividends?

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The Vanguard Australian Shares High Yield ETF (ASX: VHY) is one of the more popular exchange-traded funds (ETFs). The fund size is around $2.3 billion.

As the name suggests, it’s an investment that targets businesses with higher dividend yields from the ASX share market.

Vanguard is the provider of this investment. It’s one of the largest funds management organisations in the world. Vanguard tries to provide its investment options as cheaply as possible.

In Vanguard’s own words:

The ETF provides low-cost exposure to companies listed on the Australian Securities Exchange (ASX) that have higher forecast dividends relative to other ASX-listed companies. Security diversification is achieved by restricting the proportion invested in any one industry to 40% of the total ETF and 10% in any one company. Australian real estate investment trusts (A-REITs) are excluded from the index.

Let’s look at two of the key features of this ETF.

Low cost

Vanguard says this ETF is a low-cost investment.

Its annual management fee is 0.25% per annum. That is relatively low compared to many other investment options. However it’s not the cheapest way to invest in ASX shares.

Vanguard itself has an ETF that charges less than half this cost annually. The Vanguard Australian Shares Index ETF (ASX: VAS) charges an annual fee of just 0.10%.

Higher dividend yield

There are some businesses on the ASX where the dividends and distributions they provide make up a sizeable part of the total return over time.

The top 10 positions in the VHY ETF all pay relatively high dividends to shareholders. Those top 10 largest holdings are Commonwealth Bank of Australia (ASX: CBA), BHP Group Ltd (ASX: BHP), National Australia Bank Ltd (ASX: NAB), Wesfarmers Ltd (ASX: WES), Westpac Banking Corp (ASX: WBC), Telstra Corporation Ltd (ASX: TLS), Australia and New Zealand Banking Group Ltd (ASX: ANZ), Transurban Group (ASX: TCL), Macquarie Group Ltd (ASX: MQG) and Rio Tinto Limited (ASX: RIO).

Looking at the returns of the ETF, at the end April 2022, the distribution return had been an average of 5% per annum over the prior three years. That also doesn’t include the franking credits, which makes the income return even higher.

According to Vanguard, the forecast grossed-up dividend yield for the ETF is currently 7.3%.

Any downsides?

I think it’s important to remember that an investment isn’t a buy just because of a dividend.

In my opinion, the investment and valuation also have to make sense.

Businesses paying out most of their profit as a dividend aren’t generally known for displaying growth. They aren’t re-investing much profit back into the business for more growth. At the end of April 2022, Vanguard Australian Shares High Yield ETF had seen capital growth of an average of 2.1% per annum over the prior five years and 3.3% per annum over the previous 10 years.

Maybe that’s all investors are looking for — a little bit of long-term capital growth with strong dividend potential year to year.

For investors that aren’t seeking maximum income, I think other options could produce better total returns over the longer term as those (underlying) businesses re-invest more profit back into the business. For example, over the last five years to April 2022, the VAS ETF returned an average of 0.65% per annum more than the VHY ETF, showing that the excluded ASX growth shares made a difference to the overall picture.

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