Joseph G. Mowrer III, The Daily Record Newswire
If I told you there was a way to hire a professional fund manager for free, would you believe me? Probably not. But here’s the trick.
There are several closed-end funds that have adopted what is called a “managed distribution policy.” This means that the fund (a closed-end fund) pays out a fixed amount of its assets each month (or quarter depending on the fund) as a distribution to shareholders. The main objective of this policy is to provide a steady cash flow to shareholders. The fund manager sets this fixed distribution amount based on their long-term expectations of the total return of the fund, which can either be a percentage of the funds’ net assets or a fixed dollar amount.
For example, one closed-end fund managed by a well-regarded fund family pays shareholders a managed quarterly distribution of $.14 per share, or roughly 7.1 percent annualized based on its recent share price. This fund has set this amount based upon the expected total return (net investment income plus realized capital gains) of the investments within the fund.
Due to the volatility in the equity market, this quarterly payout can be either earned by the investments within the fund, or not. In either case, shareholders are receiving a payout of their investment in the form of a dividend and/or capital gain distribution (if earned), or a return of their own capital (if not earned). Fund managers are required to disclose the source of their distributions.
Here’s the beauty of this policy for shareholders and how it can result in hiring a professional fund manager for free. This fund (and others like it), can currently be purchased at a 13 percent discount to its net asset value. Each quarter, this fund returns to shareholders a fixed distribution of $.14 per share, which is paid from the net asset value of the fund.
Since this fund was purchased at a 13 percent discount to NAV, shareholders are actually getting a distribution that represents 113 percent of their investment each quarter! (To simplify this example, assume the fund were to pay out 100 percent of its assets; shareholders would immediately realize a 13 percent gain).
Over the course of a year, shareholders of this particular fund would receive a total of $.56 per share ($.14 per quarter), which represents a distribution yield of 7.1 percent based upon the current market price of the share of $7.83. If we calculate this same distribution yield based on the fund’s current NAV of $9.04, we get a distribution yield of 6.2 percent — a difference of .9 percent. This difference is a result of buying the shares at a discount, and more than covers the .89 percent total expense ratio that the fund reports in its most recent semi-annual report.
Investors may believe that the cheapest way to hire a professional manager is through an index fund. But as it turns out, there may be cheaper alternatives, and it truly is possible to hire a professional manager for free!
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Joseph G. Mowrer III is a senior tax-sensitive fixed income analyst for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, nonprofits and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.
