I love looking for investments that provide a pleasing source of passive income, typically in the form of dividends.
Companies that pay high dividends typically don't generate as much capital growth. Large dividend yields usually mean the businesses pay a lot of their profit as dividends, which means less re-investment for future growth. ASX-listed exchange-traded funds (ETFs) usually don't have good dividend yields.
However, I will discuss VanEck MSCI International Quality ETF (ASX: QUAL) as an option for passive income. It may not be known for passive income, but I will show how it could be an extremely effective option.
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Access the capital growth
There is more than one way to generate cash flow. Receiving dividends or distributions is one way, but we can also sell a portion of our holdings each year. I'd want to activate the distribution reinvestment plan (DRP) to ensure that as much of the ETF's returns are retained for further (capital) growth until they need to be sold.
Imagine if we had $100,000 invested in the QUAL ETF and it delivered a total return of 10% over one year—it'd become worth $110,000. That investor could then sell $5,000 of the original investment—unlocking a 5% passive income yield—and they'd still have $105,000 at the end of it.
Let's say the ASX ETF returns another 10% in year two, growing $105,000 to $115,500. If the investor sold 5% of the starting $105,000 balance, they'd have cash flow of $5,250 to utilise and an ending balance of $110,250.
In my example, you can see how both capital value and cash flow are growing. Of course, the share market wouldn't deliver a consistent 10% return year after year—it's more volatile than that. However, I think the QUAL ETF is a top ASX ETF contender for delivering double-digit returns because of how it's constructed.
Great businesses
The fund owns 300 global companies which are arguably some of the best businesses in the world.
All of the businesses need to tick three important boxes: a high return on equity (ROE), a high level of earnings stability, and low financial leverage.
What this means is the businesses make a high level of profit for how much shareholder money is retained within the business, profits don't typically decline, and they have low levels of debt for their size.
When you combine those separate characteristics, the businesses that score the highest are the best of the best from around the world.
You can probably guess which sorts of businesses feature at the top of this fund's portfolio. The biggest holdings include Meta Platforms, Apple, Alphabet, Microsoft, Nvidia, Visa, Eli Lilly, Costco and Mastercard. These businesses aren't known for their passive income, but the capital growth has more than made up for it.
It also invests in businesses that are not headquartered in the US, such as Novo Nordisk, ASML, Roche, Nestle, Astrazeneca and LVMH.
Strong returns
Thanks to rising profits, these great businesses have delivered excellent returns and strong capital growth. Their high ROE means any retained profit can be reinvested for a high rate of return.
Over the past ten years, the QUAL ETF has returned an average of 15.5% per year. But that's not guaranteed to continue in the short-term or long-term, so I'd still stick with a 5% passive income yield and 'bank' excess capital gains for future possible weaker years.
