Don’t Be Taken Advantage of by “Teddy KGB”

The following is a guest post by Wealth Effect Blogger. For more information about the author please visit www.YourWealthEffect.com.

Teddy KGB

John Malkovich as Teddy KGB

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.

FAV Market Returns

FAV Market Returns

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.

FAV Distributions

FAV Distributions

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.

HTY Market Returns

HTY Market Returns

HTY Distribution History

HTY Distribution History

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.

GCV Market Returns

GCV Market Returns

GCV Distributions

GCV Distributions

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?

More posts written by Wealth Effect Blogger.

4 Responses to “Don’t Be Taken Advantage of by “Teddy KGB””

  1. Ron Jamieson

    Jan 11. 2013

    Excellent, easy-to-understand analysis!
    In Canada, these type of Mutual Funds are presented as “tax advantaged” because you supposedly will pay capital gains tax in lieu of the dividend tax credit arrangement.
    My own experience with Webb Asset Management (primarily oil and gas) is that it went down below the NAV (already declining over the past 2 years) by roughly the % represented by the Return Of Capital!
    Sometimes, it’s worth paying taxes….

    Reply to this comment
  2. Mary Cunningham

    Jan 13. 2013

    Thank you for this post. I had no idea that the Managed Distribution policy even existed. I have checked the mutual funds I own and discovered that RBC has a generic definition of ‘distributions’ for all their funds. Yup, they include the ability to return capital.

    I suspect that this hasn’t been utilized in the funds I own. However, I will be keeping a much closer eye on the financial statements as to where the distributions have been coming from.

    Reply to this comment
    • The Dividend Ninja

      Jan 13. 2013

      Hello Mary!

      Unfortunately, I suspect that all mutual funds may return capital at some point. The real question is how often are they doing that and by how much? Maybe I should ask them. ;)

      Cheers

      Reply to this comment
  3. Christi Aguirre

    Jan 18. 2013

    Moreover and according to some closed end fund experts, a managed distribution policy is an effective way for closed end funds to narrow or even eliminate closed end fund discounts as well as support a closed end fund’s share price when markets are in decline.

    Reply to this comment

Leave a Reply

*