Navigating the BMO US Dividend ETF (ZDY.TO) Cut: Is This the New Reality for Income Investors?

The BMO US Dividend ETF (ZDY.TO) has sent ripples through the income investing community after announcing a 12.5% reduction in its March 2025 distribution, dropping to CAD 0.07 per unit from CAD 0.08. This marks a break from a consistent payout streak since late 2024 and raises critical questions: Is this cut an isolated adjustment or a harbinger of broader dividend instability? How should investors recalibrate their portfolios? And do alternatives like IQDY or sector-specific ETFs offer better yield stability?

Let's dissect the implications and map out actionable strategies.

The Cut: A Strategic Shift or a Sign of Weakness?

The March 2025 distribution cut was framed as a “strategic adjustment” to evolving market conditions. Yet, its timing coincides with broader trends in U.S. equities.

Key observations:
1. Underlying Portfolio Dynamics: The ETF tracks U.S. dividend-paying stocks, many of which may have reduced payouts amid economic uncertainty. For instance, sectors like energy and financials have faced margin pressures, dampening their ability to sustain high dividends.
2. Currency Considerations: While the USD-denominated counterpart (ZDY.U.TO) saw a proportional cut, this wasn't due to hedging—it aligns with the CAD distribution when adjusted for exchange rates. Thus, the cut reflects portfolio-level challenges, not currency risks.
3. Market Sentiment: Investors may interpret this as a warning sign. BMO's risk management appears cautious, but repeated cuts could erode trust in the ETF's income reliability.

Assessing Payout Sustainability: What Investors Need to Monitor

To gauge whether this is a one-off or the start of a trend, focus on these metrics:

1. Dividend Stability of Underlying Holdings

• Corporate Dividend Trends: Track the U.S. equity universe's dividend growth. For example, S&P 500 dividend growth slowed to ~5% in 2024 from 8% in 2023. Sustained deceleration could pressure ZDY.TO further.
• Sector Exposure: ZDY.TO's top holdings (e.g., utilities, energy, and consumer staples) often prioritize dividends. However, if these sectors face earnings headwinds (e.g., rising interest rates), payouts may shrink.

2. NAV Resilience

• Price-to-Distribution Ratio: A falling NAV relative to distributions signals capital erosion. As of April 2025, ZDY.TO's NAV was CAD 41.35, supporting a 2.12% yield. But if NAV declines further while distributions stagnate, the ETF's total return suffers.
• Liquidity Risks: While ZDY.TO trades actively, prolonged market volatility could tighten liquidity, complicating exits.

3. BMO's Risk Management Track Record

The fund's manager has historically balanced income and capital preservation. Yet, a >3% yield drop in 2025 (from 2.4% to 2.12%) hints at tougher choices ahead.

Alternatives to ZDY.TO: IQDY, XLU, or Sector-Specific Plays?

Option 1: IQDY (FlexShares International Quality Dividend Dynamic Index Fund)

• Why Consider It?
• Recent Dividend Growth: IQDY increased its annual dividend by over 3% in June 2025, showcasing resilience.
• Diversification: Tracks high-quality international equities (ADR/GDR), reducing U.S.-centric exposure.
• Risk Mitigation: Focuses on firms with strong balance sheets and consistent payouts, minimizing volatility.
• Drawbacks:
• Higher expense ratio (~0.99%-1.40%) vs. ZDY.TO's 0.29%.
• Foreign currency exposure adds complexity.

Option 2: XLU (Utilities Select Sector SPDR Fund)

• Why Consider It?
• Stable Yields: XLU's 2.81% distribution yield (as of June 2025) is underpinned by utilities' defensive nature.
• Low Volatility: Utilities are recession-resistant, with top holdings like NextEra Energy (11.5% of XLU) offering stable cash flows.
• Drawbacks:
• Sector concentration risks (e.g., regulatory changes or energy transition pressures).

Option 3: VDE (Vanguard Energy ETF)

• Why Consider It?
• Higher Yield: VDE's 2.9% yield (June 2025) outpaces ZDY.TO's.
• Growth Potential: Energy companies often reinvest profits, but dividends may fluctuate with oil prices.
• Drawbacks:
• Cyclical volatility: Energy is sensitive to commodity prices and geopolitical risks.

Actionable Portfolio Adjustments for Income Investors

1. Diversify Income Streams
2. Mix Defensive & Growth Sectors: Pair XLU's stability with IQDY's global reach. Avoid overconcentration in any single ETF.

3. Sector Rotation: If you retain ZDY.TO, pair it with a utilities ETF like XLU to hedge against U.S. equity volatility.

4. Prioritize NAV Health

5. Avoid ETFs with shrinking NAVs relative to distributions. Use tools like the price-to-NAV ratio to spot capital erosion.

6. Rebalance for Consistency

7. If ZDY.TO's yield drops further, consider gradual exits and redeploy capital into funds like IQDY or XLU.

8. Monitor Corporate Actions

9. Track dividend announcements from ZDY.TO's top holdings. A wave of cuts in its portfolio could signal deeper trouble.

Final Take: ZDY.TO's Viability Post-Cut

The ETF remains viable for income seekers provided two conditions hold:
- Dividend Stability: No further cuts occur, and the yield doesn't drop below 2%.
- NAV Resilience: The CAD 41.35 price holds, avoiding a death spiral of falling NAV and reduced payouts.

However, investors must now treat ZDY.TO with caution. Its 12.5% cut underscores the fragility of income-focused ETFs tied to volatile equity markets. Diversification into sector-specific or international dividend plays like IQDY or XLU is prudent to mitigate risk.

Final Advice: Keep ZDY.TO in your portfolio but cap exposure at 5-10%. Pair it with defensive sectors and international funds to balance risk. For pure income stability, XLU's utilities or IQDY's quality focus offer safer havens.

Investment Grade: Hold with Caution
Risk Level: Elevated (Monitor Closely)
Best Use Case: As part of a diversified income portfolio, paired with sector-specific ETFs.