The following is a guest post by Wealth Effect Blogger. For more information about the author please visit www.YourWealthEffect.com.
In the movie Rounders there is a scene where John Malkovich’s character, “Teddy KGB”, and Matt Damon’s character just finish a high stakes round of poker. Matt is smiling as he collects the money in the pot after winning the round. Instead of getting mad, Teddy KGB boasts how he is simply paying Matt’s character back with some of the money Matt lost to him earlier. Matt’s smile quickly fades as Teddy’s smile gets bigger.
The mutual fund world has their own version of “Teddy KGB” and it’s called a Managed Distribution Policy.
Most mutual funds that regularly make dividend (stock funds) or interest payments (bond funds) to their customers tend to have each payment be similar but not necessarily identical in value to each other. For example: $1.10 this payment, $1.05 the next, $1.11 the one after that, etc.
A Managed Distribution Policy, however, pays a fixed amount each time. For example: $1.10 this payment, $1.10 the next, $1.10 the one after that, etc. This feature alone is fine. I assume the fund manager would plan out what the payments are likely to be over the course of a year, divide that number into either monthly or quarterly payments and pay out that amount every cycle. But that is not how it works.
Here is one disclosure I came across, emphasis is mine.
Certain funds have adopted a “managed distribution policy.” Regular distributions throughout the year may include realized and unrealized capital gains, along with net investment income, and may from time to time also include a return of capital.
They’re paying you back with your own money! But that is not how it is presented.
All distributions that are made (from the actual fund performance or from return of capital) are lumped together in the yield calculation so it appears that a fund has a great yield when in fact some of all of that money could just be your principal being returned to you.
How do you know if your fund has a Managed Distribution Policy? The prospectus will tell you or you can look at how the fund has performed over time. If the market is doing well but your fund keeps losing value while continuing to pay a strong dividend then that is a good indication of a Managed Distribution Policy.
Here are three examples I came across:
First Trust Active Dividend and Income, symbol FAV.
This first chart shows the price of the fund (beige line) and the fund is about $7 per share and has steadily been declining for the past three years even as the stock market has recovered nicely.
This next chart shows the dividends from FAV. Investors in this fund has been served a double whammy of falling dividends and a falling stock price.
John Hancock Tax Advantage Global, symbol HTY
These are the charts of John Hancock Tax Advantage Global, symbol HTY. Once again, essentially no growth in value in the last four years which is very different from how the stocks this fund holds have performed.
Gabelli Convertible and Income Fund, symbol GCV
Here are the charts for Gabelli Convertible and Income, symbol GCV, from about $11 a share in 1995 to about $5 a share 18 years later.
charts and graphs source: www.CEFConnect.com
Readers, what has been your experince owning funds with a Managed Distribution Policy? Were you aware such a policy even existed?
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