Why do some ASX ETFs have dividend yields of 20% right now?

How is it that some ETFs are delivering such eye-watering returns?

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A strange observation can be made of many ASX exchange-traded funds (ETFs) right now. Namely, that they seemingly boast dramatic and what one might perceive to be unrealistic trailing dividend distribution yields right now.

Take the iShares S&P 500 AUD Hedged ETF (ASX: IHVV). Today, this ASX ETF has a trailing distribution yield of 21.42%. Typically, if an ASX dividend share has a yield of, say, 4%, it’s considered a potentially strong income share. But 21.4%? Is this too good to be true?

It’s not just that particular ASX ETF either.

Some more high-yielding ASX ETFs

Today, the BetaShares Global Cybersecurity ETF (ASX: HACK) seemingly offers its investors a trailing distribution yield of 9.6%. Not quite as impressive as 21.4%, but still substantial nonetheless.

Or the Vanguard International Fixed Interest (Hedged) ETF (ASX: VIF). It’s putting up a trailing yield of 15.05% right now. For the BetaShares Global Sustainability Leaders ETF (ASX: ETHI), a yield of 9.05% is apparently on offer.

By now, you might be smelling a rat here. Most ASX ETF investors know that the US S&P 500 Index (INDEXSP: .INX) is not a market known for its generous dividend payments. So a 20%-plus yield for an ASX ETF covering this index seems very out of place, even if it is hedged.

And interest rates are still at record lows right now (0.1% in Australia) so the Vanguard Fixed Interest ETF should not be offering a yield of more than 15% right now. So what’s going on here?

Well, these payments are not true dividend distributions. An ETF works by holding a basket of shares within them. In the case of the S&P 500 ETF above, this is the 500 or so companies in the S&P 500 Index.

Many of these companies pay a dividend so the ETF receives this money and passes it onto its investors. But that’s not what’s happening for the most part here.

Not all is as it seems…

Another notable feature of an ETF is how it rebalances itself. An ETF normally tracks an index, an index whose underlying shares change in value over time. The ETF needs to take this into account, otherwise it wouldn’t be doing its job of faithfully tracking its index.

As such, ETFs, like those above, periodically ‘rebalance’ themselves. They do this by selling the shares that have increased outside their index allocations and by buying the shares that go under. In times of rising markets, there are usually more winners than losers in this regard.

Because of this, the ASX ETFs in question usually find themselves with a surplus of cash after the rebalancing is complete.

What to do with this extra cash? Send it out the door in the form of dividend distributions, of course. So that’s why these ASX ETFs seemingly boast such high trailing yields right now.

So don’t get too excited when you see the IHVV ASX ETF pay out a distribution of 21.4%. It can be classed more as a one-off capital return rather than a consistent dividend yield.

Digging a little deeper, and iShares tells us that IHVV’s ‘true’ trailing dividend yield (what it receives from its underlying shares) is actually sitting at 1.41% per annum.

Sorry to burst the bubble.

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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and has recommended Australian Ethical Investment Ltd. and BETA CYBER ETF UNITS. The Motley Fool Australia owns shares of and has recommended BETA CYBER ETF UNITS. The Motley Fool Australia has recommended Australian Ethical Investment Ltd. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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