BMO reins in fund distributions

By Dan Hallett, CFA, CFP

I have been writing about monthly income investment funds for nearly a dozen years, putting their distributions to the test and highlighting such funds’ mythical tax advantages.   Over the past two years, I’ve been particularly critical of the BMO Monthly Income fund.  So I was pleased to discover that BMO is making some positive changes to the fund and its Global sibling.

Spring Cleaning

Early this year, BMO Asset Management announced to the advisor community that it was slashing regular cash payouts on a handful of funds.  Of particular interest to me was that both BMO Monthly Income and BMO Global Monthly Income are slashing cash distributions.

According to a BMO advisor communication, BMO Monthly Income will reduce its distribution from $0.06 per unit monthly to $0.024 – a reduction of 60 percent.  BMO Global Monthly Income will see its distribution fall from $0.055 to $0.016 per unit monthly – a 71% cut.  Both changes kick in on May 16.

This is a good news/bad news story.  This is good because it was clear the current distributions are just not sustainable.  So the cuts improve sustainability by definition.  But as we warned this cut will hurt investors who rely on the payout to pay living expense – or worse to service a leverage loan.

Sustainability

BMO Monthly Income’s pending distribution cut will bring the fund’s payout into a range that I estimate should be sustainable longer term.  When I first examined this fund, I estimated that the fund’s stocks would need to punch out 17% per year compounded annually for a long time just to keep up the cash payout without eroding capital.

Given that about 1/3rd of this fund’s distributions have been taken in cash over the past five years, this is a significant development.  While it’s hard for those who really depending on this payout, they can at least take comfort in the sustainability of the lower payout level.  But I’m told that a new series of units will be issued offering a continuation of today’s fatter payouts – mirroring steps taken in the past by firms like IA Clarington and Mackenzie.

Recent Sustainability Tests

BMO Global Monthly Income is much smaller fund but has long sported a more aggressive cash payout.  While its pending distribution cut is big, I estimate that it needs to fall further if long-term sustainability is the goal.  But BMO is hardly the worst offender when it comes to aggressive distribution levels.

As the table below shows (click to enlarge it), funds from IA Clarington, NEI Investments, RBC and Standard life continue to ‘over-distribute’ in my estimation.

I’m pleased with BMO’s upcoming changes.  Let’s hope more companies follow this path to sustainable payouts.

 

   
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44 comments to BMO reins in fund distributions

  • Ken Hine

    Do you think that the unit value of the BMO Monthly Income fund will drop substantially when the distributions are lowered?

  • Ken, the short answer is no. In fact, the unit price – which is 30% lower than it was when the fund began 12 years ago. While the fund has made money overall, its unit price has fallen because more than 100% of the fund’s total return has been paid out in cash. The fund’s annualized return, since inception, is more than 5.5% annually.

    That 5.5% per year return has been ‘delivered’ to investors via…

    - monthly cash distributions averaging about 8.5% per year since inception; and
    - a unit price that has fallen about 2.5% annually.

    So 8.5% – 2.5% = 6% per year. So the fact that they’re now paying about 4% per year in monthly cash distributions means that there will be less cash paid out to unitholders – which means more cash staying in the fund (i.e. more assets staying in the fund for each investors instead of paying it out).

    A corporation pays dividends out of its after-tax earnings. The price of a stock falls after a dividend cut for two reasons. First, many people value stocks based on their dividends. So if the dividend is less, the value calculation comes out lower.

    Second, the dividend is a ‘signal’ that management is not confident about the future earnings of the business. And if management – who is supposed to know more than anybody about the business – isn’t too confident, then investors will assume the worst (at least initially).

  • Ken Hine

    Dan, Thanks for your reply.Very helpful.

    I spoke today with a rep from BMO who indicated that BMO is planning to create a new monthly income fund (“R” units)with a monthly distribution of 0.03, and it will also maintain the existing fund as well with a 0.06 monthly payout. According to BMO, investors will have a choice. This seems to be a good move on their part.

    Ken

  • Thanks for your note Ken. Glad you found this helpful. The communication I have from BMO actually says that the original fund (referred to as series A) that has been around since the late 1990s will see its distribution cut to the new amounts I specified in the article.

    The new series R units of BMO Monthly Income will be launched and offer the original $0.06 per unit monthly distribution. So for people who want to keep their higher payouts, they’ll have to switch to the new R series units (which can be done on a tax deferred basis).

    This is a good move on BMO’s part because other companies that have done this in the past have taken the reverse course. They’ve kept the higher distribution on the fund with the most money in it while launching new series of units with lower distribution rates. That’s a little sneakier in my view.

    BMO’s move is a little gutsier – though I’d like to see them do away with such high payouts altogether. Still, I agree that this is a good move and a more sustainable policy for the people still sitting in the affected BMO funds.

  • Mike Carney

    Here we go again, more bad news for fund customers and more bs from so called experts. Yes, I was talked into buy into this fund in 2004 because I wanted a cash income from my rsp and bought in at over $10.07 per share, of course right away the fund has fallen to a new low just over $7.00 per share, wow great fund management people! “NOT”.
    Yes ,now we are told we should be pleased or that there is going to be a NEW GREAT FUND excuse me , The Nerve of some Management people , Never NEVER will I purchase another investment from BMO.
    Harse you say! Well I had to hold back on the language of what I really wanted to say.

  • Not sure why you’re angry with me Mike. If anything, I’ve been warning – through my public writing – against spending the cash payouts from these high payout funds since 2001. The articles have been online since then and they’re easy to find online.

    BMO Monthtly Income is not a fund I’ve ever recommended but it’s fine. It’s a balanced fund with reasonable fees. The issue isn’t the fund itself but its policy pertaining to distributions – i.e. how much is paid out and how much of that people actually spend.

    Clearly it’s an advisor’s obligation to ensure that they understand well the products they sell to clients and to make sure that the product is suitable for clients.

    But in 2004 a 5-year GIC could be had for about 4% per year (posted rates peaked just above 3%). In that environment, you say that a fund was recommended to you that paid out more than 7% annually (much of which was not taxable).

    Did you ever wonder to yourself about the risks of an investment paying out monthly cash at a rate that nearly doubled GICs before tax (and more than double after-tax)?

    Did you ask about the risks involved or do you remember the advisor talking to you about any risks at all with this fund?

  • Mike Carney

    No ones angry at you, only person to blame is the person in the mirror, who mistakely fell for a bunch of BS from a bank employee, Now I know my Grandfather was right , save your soup cans for burying your money and hiding it from the goverment of the day and from banks. LOL have a nice day. venting in B.C.

  • Paul N

    Hi Mike, Dan,

    I’m not sure what Mike is upset about. He should do the math. For example if one adds up all the 6 cent monthly distributions per unit that he received (since 2004) then adds it to the number of units he owns X $7.18 (todays price apx) I’m sure he will find he hasn’t really lost any money. (he may not have made as much as someone investing in other investments, so he has possibly lost some “opportunity costs”)

    The fund has made an avg. 4% return over the last 5 years. The share/unit value yes has dropped, but people keep forgetting/ignoring – depending on what you did with those distributions you are still in the black.

    I’m more worried now that this “rumor” get’s out and a bunch of frightened investors start yanking their money out of this fund in a stampede. That will affect unit price. And really for no reason…

  • Mike, apologies I misunderstood. When you said “expert” I didn’t realize you were referring to a bank advisor. But Paul N’s comment is spot on. I’d encourage you to read his reply as well as my reply up above to the first question in this post.

    The total return is the total return. Some of that may come in the form of a cash payout. Some in the change of unit price. Varying how much comes from cash payouts vs. unit price movements doesn’t change the total.

  • Paul N

    Thank you Dan,

    Now that you agreed with me can you explain why you are critical of this fund?
    Lets look at its 10 year return (AFTER MER’s)

    Returns as of February 28, 2013
    Fund Group Avg Index*
    1 month 1.37% 1.34% 1.34%
    3 month 3.42% 4.08% 4.08%
    6 month 5.05% 6.19% 6.06%
    1 year 4.29% 5.51% 5.49%
    3 year 6.06% 5.11% 5.11%
    5 year 4.09% 2.94% 2.72%
    10 year 6.19% 5.78% 5.11%
    15 year n/a 4.36% 3.85%
    20 year n/a 6.13% 5.92%

    10 years 6.19 % total avg. return

    This is why I have trouble agreeing with “critics” of the fund. Some advisors putting together a “designed” portfolio of funds for a client and charging a fee for doing so can’t even get that return… (It’s black and white right here).

    I guess your worried about people becoming complacent with the steady dividend and relying on that for returns? With growth funds you have to sell unit’s. With the BMO fund you might have to sell some units and use some of the payout. I don’t really see anything wrong with either approach as long as it’s thought out by the investor and they have some semblance of a plan…

  • Mike Carney

    To answer this question: Do you think that the unit value of the BMO Monthly Income fund will drop substantially when the distributions are lowered?

    YES oh I see another reply here with lots of figures and charts and so on, where have I seen this type of selling before oh yeah, in a financial advisor’s office! enough said this is my last reply. good luck friends

  • Paul, your point is valid in that the fund looks pretty decent, fees are reasonable and total returns have been good. I have never criticized any of those aspects of this fund. It is really in the way this fund and others like it are/have been sold to end investors.

    And the selling starts with BMO’s own website. On the main profile page for this fund, to the right, it says that this fund is suitable for investors who want regular monthly cash flow with the potential for capital gains. But further in the objectives, it says that it aims to pay a fixed monthly distribution while preserving the value.

    It has delivered on paying income and then some – in a fixed monthly basis. But it hasn’t generated capital gains over and above that monthly payout and it certainly hasn’t preserved the value net of the distribution. More importantly, investors see this and assume that the monthly cash payout is yield when clearly it’s not. People will assume it’s safer because it’s got a big bank name/logo attached to it.

    But before buying such things, people need to at the very least look at what a truly guaranteed alternative is offering. Then, if presented with something that offers 2-3x the guaranteed start asking about what risks exists because they always do. If it looks/sounds too good to be true; it is.

  • MIke Evans

    Is there a relatively easy way to tell whether or not a fund payout is not yield? I checked the documentation on the BMO website and I don’t see this clearly stated although perhaps this has changed from what they had before or maybe I’m just missing it. I own another BMO fund and I will immediately sell it if they are not being clear.

    Thanks Mike

  • Allen W

    This whole subject is of much interest to me since it is only this month that I realised Royal Bank (RBF) Funds, and as noted in your article many other, if not all, major Funds finance their Monthly, Quarterly and annual Distributions and Capital Gains Distributions by automatically reducing the fund unit price on the date of the distribution by the value of the Distribution. It only came to my untrained eyes because on day in question , March 28th the Quarterly Distribution date, my Fund was supposed to increase but in fact decreased by the value of the Distribution. Since their documentation makes no mention of this, as the basis of paying the distributions, I find it to be scandalous that Canadian Government and Banking Regulations do not view this as “Lying by Omission” when the banks and other financial institutions publish and quote fictitious Fund Returns.

  • Steven L

    Paul N,

    Those numbers you posted are way off. Be wary of where you get your data. Make sure that the fund is being compared to peers in the same CIFSC category, because I can guarantee the data you have there is not accurate.
    ————————————————–

    The quality of BMO Monthly Income is just fine. How the distributions are used is this issue. If it is spent on discretionaries and vacations, that is the investor’s choice. If it is used inside an RSP, its distribution rate and price should not matter anyways as the distributions MUST be reinvested. Remember your net return is distribution + price movement. What you own is price * # of units. Don’t look at one side of the equation and ignore the other.

  • Ronald

    Allen, all funds unit price is reduced after a distribution to account for the fact that the value of the fund is lower by the amount of the payout. If not, you could buy the day before the distribution, get the distribution and than sell the following day at the same price; that doesn’t make any sense.

    The problem is when the funds pay out more than it earns (return of the fund). It basically pays you back with your own money.

  • @Mike Evans:

    You are correct that the websites of the various fund companies will not likely tell you this information. There are two ways to assess the distribution.

    One way is simply by looking into the past – and BMO Monthly Income is a good example since Paul N posted some figures up above. BMO Monthly Income has returns 6.2% per year on a compounded basis since inception (through Feb 2013). Its distribution rate has been around 10% per year for some time. If the total return is less than the distribution, the fund would have over-distributed in the past.

    Another clue from historical data is looking at the distribution rate. At inception, BMO Monthly Income was paying $0.06 monthly per unit on a $10 unit price – an annualized payout rate of 7.2%. That 7.2% has grown over time – a sign that the distribution has slowly ground down the unit price.

    Secondly, the forward-looking method I used on BMO Monthly Income more than two years ago. And it’s the same method I used back in 2001 to initially test a Clarington fund’s distribution sustainability.

    In short…
    a) you calculate the distribution rate before fees (this is the fund’s total return requirement);
    b) determine the bonds’ weighted yield to maturity – a good estimate of future returns – by calling the company or estimating it using bond ETF yield data;
    c) multiply that yield by the % allocation to those bonds (to see what bonds will contribute to the total fund return);
    d) then take the result from (a) and deduct the result from (c) to figure out how much the stocks have to contribute to the total fund return; and finally
    e) take the result from (d) and divide it by the % allocation to stocks and that will tell you what the stocks have to produce to support the distribution without eroding the unit price.

    It is this process that I ran through for about 10 funds in the table at the end of this blog post above.

  • @Allen W:

    Ronald’s response to you is correct. An old textbook of mine, in an attempt to make the case that dividends don’t matter in theory, explained it this way (and I’m paraphrasing):

    Pretend that a stock or a fund is a shoebox. Instead of stocks and bonds the shoebox (or company) simply contains $100 in cash. This hypothetical company has a net asset value of $100.

    If you take $3 out of the company to pay a dividend to its owners, the NAV falls to $97 because $3 was removed to be placed in the hands of shareholders. But now shareholders have $3 they didn’t have before. Add that $3 to the $97 NAV and you still have your original $100 company value. Economically, there is no change in wealth. This is why all stocks and funds will fall in price by the precise amount of their dividends or distributions.

    If the market was flat that day, that’s the only change you’d see in the prices of dividend-paying stocks and funds. But whether it’s a good or bad day in the market – and the market’s view on a particular stock – will also influence whether a stock or fund is up or down on the day that the dividend/distribution comes out of the price.

  • @Steven L:

    The data that Paul N posted appears to be just fine. He obtained the data from GlobeInvestor, the numbers from which line up with what Paul N posted. GlobeInvestor have it classified as a Canadian Neutral Balanced fund and compare it agains that group.

    According to the CIFSC (of which I am a member), BMO Monthly Income is a Canadian Neutral Balanced fund. Morningstar has slightly different figures for the group average returns but this could be attributed to two factors. It could be that Mstar weights returns by assets. But also notice that Mstar now uses March data while GlobeInvestor still shows Feb returns.

    But you are correct in stating that the quality of the fund is separate from the issue that I’ve written about so many times. And that is the fund’s distribution policy and what investors are actually doing with the distribution. While BMO continues to say that 20% of investors take the distribution in cash, 33% of the total dollar amount of distributions over the past five years were paid in cash.

  • Steven Lo

    Dan,

    Regarding the data, I am comparing side by side Morningstar Feb. 28th numbers to Gloveadvisor Feb. 28th numbers. The difference between average category peer returns is significant. As of Feb. 28th, average Canadian Neutral Balanced funds have returned 6.0% annualized over 10 yrs, compared to 5.78% on Globeadvisor, and 3.4% over 5 yrs compared to 2.94%.

    I personally feel there is nothing wrong with a QUALITY fund having a high distribution rate insofar that the distributions are being used wisely. At the end of the day it comes down to whether or not the investor is properly informed or not on this potential capital erosion. We have clients using funds with aggressive distributions all the time for life insurance/mortgage repayment/dollar cost averaging purposes all the time.

  • Thanks for the updated figures Steven. Those differences between Globe and Mstar on peer group returns are the kinds of differences that are typical of a simple average vs. an asset weighted average calculation. Globe, Fundata and Mstar are all part of the CIFSC and all agree on consistent classifications. So their classifications match those of the CIFSC in virtually every case.

    What differs is whether each data provider is calculating a median return for the group, a simple average or an asset weighted average – and whether each calculation includes dead funds or only those surviving the entire time period. Also, each data provider may differ in how they treat funds that used to be in one category and ‘jumped’ to another. Those issues easily explain the differences you see for the Feb return data.

  • Rob Parsons

    Dan, the chart was very helpful to me in demonstrating your point about BMO’s funds not being sustainable–at their former distribution levels. What it also tells me is you are saying the only sustainable funds are RBC Monthly Income, TD Monthly Income and, with the new distribution, BMO Monthly Income. I own units in the CI Signature High Income Fund. Should I “be afraid, be very afraid”?

    Rob

  • Rob, I have no concern about CI Signature High Income. In the table I show my estimate of what each of the fund’s listed can sustain in terms of a monthly per unit distribution. The line below then shows the % difference between that estimate and the current distribution.

    These are estimates so I wouldn’t sweat a difference of 10% or less. My calculations for CI Signature High Income show that its sustainable distribution is about 6% lower than its current payout. That’s such a small difference that I wouldn’t worry about it. But CI’s internal monitoring should add to the comfort level in terms of the fund sustaining its payout.

    CI monitors the distribution sustainability on a quarterly basis by looking at each portfolio’s pure yield, comparing that to the prevailing payout rate and assessing whether the payout is reasonable. The table shows that the current payout is about 8% before fees.

    The pure yield component of this fund is about 5%, leaving 3% needed from realized and unrealized capital gains. It’s not a slam dunk because rising corporate and high yield bond prices have really pushed yields down. But it’s well within the realm of possibility and not far off of my best guess.

  • Shelly R

    Dan,
    The new series R units of BMO Monthly Income will be launched and offer the original $0.06 per unit monthly distribution. So for people who want to keep their higher payouts, they’ll have to switch to the new R series units, will the unit price be same as the the original fund (referred to as series A) ?

  • Shelly, virtually every new mutual fund is launched at a $10 per unit price. But for the purposes of switching from one series to another, the prices don’t matter. If you have $50,000 of BMO Monthly Income Series A you hold about 6,983 units of the fund. If you switch to series R right at the launch date, you’ll get 5,000 series R units at $10/unit. Your total value is $50k in either case.

  • Shelly R

    Dan,
    Follow up question.
    I hold substantial amount. Bought it through the BMO branch.
    My initial principal has erode substailly as well.
    I would like to get out of it.And I will only question When.

    1.As I will getting out of it shortly Should I go for Series R or stay with series A?Which would have a less blow?
    2. Next question is wait a month or so to see if the Unit price increases reducing my losses?

    2.

  • Shelly, if you’ve already assessed the situation and decided to exit the fund shortly, it doesn’t much matter which series of units you’re in. Series R and A units of the fund will have the same total return. Series R will simply be paying more of that return out in the form of a cash distribution. But if you need more cash you will prefer series R – and that’s fine so long as you’re aware that there is likely some capital erosion in that monthly cash payout.

  • Ken Hine

    Dan, I’ve held BMO Monthly Income fund for years and watched the unit value go from the $10 range to the $7 range. I want to sell it. If I sell, will I realize a capital loss? Is there a chance there will be a capital gain? Thanks.
    Ken

  • Ken, I sympathize with your situation. I’ve seen these high payout funds since my early years in this industry so these products have been misunderstood for a very long time by both the people that sell them and those that invest in them.

    As to your tax question, this article by John Heinzl in the Globe & Mail does a great job of explaining the tax impact of return of capital (RoC) distributions.

    In short, a capital gain is possible because each RoC payment you get in cash reduces your cost for tax purposes (i.e. ACB or adjusted cost base). So even where your remaining investment has gone down in value, you could face a capital gain.

  • Shelly R

    Dan,
    Just spoke with BMO Financial Planner 2 BMO Branch.
    He said I can convert my Units to Series R ,immediately @ same price per unit as Series A.
    He said BMO is already selling Series R . Yesterday it was Series R per unit price was $7.17 cents.
    I asked he call the Mutual Fund Dept @ BMO that handles this fund just to make sure he is giving me correct info.
    His answer,he does not need to. The series R sold yesterday @ $7.17 per unit.

  • Thank you Shelly for the update and for clarifying. My impression was that series R would be a new series starting at $10. Based on what you’re saying, existing investors can switch to series R to keep the same amount of cash flowing out each month. Sustainability remains an issue for such investors but hopefully they’re more informed on this point and don’t rely on the cash payouts for too many years.

  • Yas A.

    Hi Dan;
    Thanks for your explanations. Quite helpful. I owned the BMO montly income for years. Though the unit value went down a lot, however, overall, I don’t think I lost money. My main concern now is whether the unit value will go up with this change? I would definitely stay invested in this fund if this is the case… otherwise, it is not exciting any more … who knows!

    Yas A.

  • Glad you’ve found this informative Yas. If you’ve owned the fund for any length of time you’ve probably made money overall when counting both your cash distributions and your remaining capital. The total return will be no different between series A and R going forward. The only difference will be the form in which BMO will ‘deliver’ total return to investors.

    If we assume that this BMO fund generates a long-term return of 6% per year going forward, series A will deliver this in the form of 4% in annual cash distributions + 2% per year in rising prices. Series R, on the other hand, seems poised to do this with a 10% annual cash payout and a 4% annualized DECLINE in the unit price.

    The total is the same. Investors simply need to be aware of this and decide what’s appropriate for their circumstances.

  • Dan W

    Dan Hallett,
    Thanks for your very helpful information. You have answered several questions that my BMO Financial Advisor could not or would not (not sure which). When I asked for more information so that I could really understand the details of how the Montly Income Fund ‘yield’ works I was told that there was nothing there for me from BMO’s website or in print.

    We have both BMO Monthly Income Fund units and BMO Diversified Income Funds. BMO only offered us the ‘R’ Fund switch possibility for the Monthly Income Fund because we were not reinvesting the monthly distribution. Because we were reinvesting the monthly distribution of the BMO Diversified Income Funds there is apparently no ‘R’ Fund option.

    We have had our two funds above for about two years. We have saved in a bank account or reinvested all the monthly distributions given to us so far in two years.

    Two questions:
    1) How long should we continue to do this assuming that we won’t need the actual montly income to live on for a couple of years?
    2) Should we reinvest in these funds or look for a way out over time when the unit price improves. We bought at about $7.90 so have ‘lost’ about $0.70 per unit to date.

    Thanks Again – d

  • You’re welcome – glad you found this helpful. To your questions…

    I don’t know the answer because I don’t know your specific goals, including cash needs with associated time frames. And this is not the forum for addressing such issues. So if you really think you’ll need the money, they keep what you need safe and accessible (i.e. in a high interest savings account) and reinvest any excess.

  • Ken Hine

    Dan W. I too was very disappointed in my BMO Nesbitt Burns advisor who basically provided little if any information about the fate of this fund. All he said was that the BMO Monthly Income fund was “not a good fund”, that I “should sell it”, and get this, invest the full proceeds in the BMO Guardian Monthly Income Fund. When I did an analysis of this fund, it looked no better than the BMO fund, and, surprise, surprise with a higher MER.
    BMO has “lost alot of good will with me” which in real money means I am big time PO’ed with them.
    Ken H

    Ken

  • Johnson

    Dan,
    You refer to the John Heinzl article above which explains how ROC is treated tax-wise once the ROC equals your original investment, namely as a capital gain. Can one assume that once that point is reached that the ROC which is now a capital gain can be offset by any capital losses just as with any other capital gains?

    Also, am I correct in assuming that any proceeds from the sale of these funds after the ACB reaches zero is entirely treated as capital gains and taxed accordingly?

    Lastly, it’s my understanding the NAV’s for series A and R will remain the same so I’m unclear how this can be since R’s distribution rate is so much higher, especially in light of what’s been written above about distribution eroding NAV over time.

    Appreciate your input.

  • Paul Roddick

    I’m watching Sprott Strategic FI move in a similar direction to the BMO fund… NAV now ~$8.30, from original $10. Is there a point at which fund mgmt is legally obligated to reduce distribution? Or an accepted threshold?

  • There is no specific legal obligation to do anything other than it has already promised in writing. And they say they will review the distribution annually and adjust as they deem it necessary to do so.

    Sprott Strategic Fixed Income is a closed end fund that is so far in its young life in a similar spot. It has a policy of paying out a level “tax efficient” cash amount equating to 6% annually but the fund made barely more than half of that over the past year. Two things to remember in this case.

    First, this is a closed end fund. Accordingly, there is a difference between the actual net asset value of the fund and the price set by the market (i.e. market price). The market price is about 10% lower than the initial opening price of the fund. The fact that distributions have well exceeded total returns has pushed the net asset value down about 9%. The other 1% nudge down is due purely to the market knocking the price down slightly below its NAV.

    Second, this is a little different than the examples I’ve used to illustrate this concept in that my usual examples are plain vanilla stock and bond funds. In those cases, it’s very straightforward to examine this from a fundamental perspective.

    This Sprott fund is really a fixed income hedge fund of sorts. Accordingly, the listed yield is part of the return. The various decisions to leverage up or go short will influence that baseline yield up or down. And it’s really difficult to gauge what kind of additional return those bets will produce.

    Even if it’s successful, it’s not unusual for a hedge fund to produce a great track record by having lots of ho-hum years with the occasional head-turner mixed in. In between those big wins, the distribution will grind down the NAV. But Sprott will review the distribution annually and adjust as necessary to keep the NAV from sinking too low while they await the big performance spurts.

  • Johnson, to your three questions…

    1. You are correct that the “capital gain” resulting from RoC distributions paid out after a fund’s ACB hits zero is no different than any other capital gain (i.e. selling a stock at a profit) that is generally matched against capital losses in the same year (or other years).

    2. You’re also correct that selling a fund with a zero ACB would effectively make all of the proceeds treated as a capital gain.

    3. When a fund launches, its unit price can, in theory, be set at any price the fund company desires. In other words, if BMO starts a new fund or series and they put $1 million of seed capital they can pick a price of, for example, $7.19. All that means is that the fund – at that moment – has 139,082.0584 units outstanding at a price of $7.19 per unit. But it could just as easily pick a $10 unit price (which is most common), which would only change the initial # of units outstanding. Once the fund is launched, however, it’s the performance of the underlying portfolio that will drive the changes in the price. And any buys and sells occur at the prevailing price.

    To the differences between series R and A for BMO Monthly Income, the same concept applies. BMO can use whatever initial price it wants – or change the price of an existing fund. Like a stock split, any change in price has a corresponding and proportionate impact on the # of units. So the point at which distributions change later this month, series R and A will have the same price.

    But over time you are right in expecting the series A unit price to stay ahead of series R units because of A’s subsequently lower distribution.

  • Simon

    I am going to step in here and ask a few questions.

    First, I am personally upset they lowered the distribution.
    My view- I agree the distribution was never the issue.. The issue was a lack of clear explanation of where it came from.

    I think we need more securities like the series R (with simple explanations), because capital-gains-based investing simply does not work for the average Joe.

    Here’s why: The average person is told to invest savings for the sake of capital appreciation. But rarely does the average Joe cash out their stock at a point where they see those returns.

    In most cases, they cash it out in times of need. Times of need for an individual are most often during global economic decline. Take the most recent recession- The economy is looking really bad, there are massive layoffs at work, and AJ (Average Joe) is seeing his portfolio decline. In many cases, the honestly right move at that time is to cash out and protect his home and family’s immediate financial security. If he loses his job- which many people do- then he may have no choice.

    Now, the well-educated (and well paid) experts will criticize this move- but what the fund managers don’t understand is that average people have true expenses and limits. Average Joes are not the cream-of-the-crop who have job security. They lose jobs, they dip into savings, they need to re-educate, they have life expenses that must be funded. People should be told to invest for the distribution or dividend, but even then, bad things happen, of course…

    So now, my point: Who is richer in the recession: The guy that sold the Income Fund or the guy who sold a growth fund? Answer: The guy who sold the Income Fund, because he was getting distributions (even if as return of capital) for the past 2 years. The regular payouts hedged against the downturn.

    Furthermore, since such funds focus more on maintaining the distribution, AJ is more likely to keep the fund (as I did) since the regular payouts can assist with regular expenses.

    So, I think the problem is the investment community pushing capital gains as the solution to the average person’s problem.

  • Sorry to resurrect an old thread.
    Sometimes you can’t win. One of my colleagues was on vacation and one of his clients ( a math professor from the local university) came in. He was not happy. His Industrial Income Fund was losing money he said. He was not happy. I checked Paltrak at the time and no, the fund was making money during all the time frames he had the fund.
    I eventually figured out he was looking at just the unit value which was dropping steadily throughout the years thanks to a large ROC payout.
    Although he was reinvesting all of the lofty distributions, he still claimed he was losing money. Just look at the unit price he said. It has fallen dramatically he said. I pointed out that the number of units had risen dramatically to compensate but he just wasn’t convinced.
    In desperation, I drew two “pies” on a piece of paper.
    One pie was much smaller than the other. It had six slices. The much bigger pie had far more slices.
    I asked which pie would he rather have.
    “The smaller pie he said: ” The slices are bigger!
    That is why I don’t sell ROC funds.

  • Thanks or your note. Interesting story. And ironic that a client who really has nothing to worry about in this context is focused only on the unit price and not on his own position/returns.

    Kudos to you for not selling ROC funds – particularly those that ‘over-distribute’.

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+ five = 10


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