Trying to get my head around dividends in open ended funds...

[nmdhqbc]

I was thinking about how inflows and outflows of cash could effect the divi payments and really struggling to get my head around it. So I decided to just work through an over simplified and exaggerated example. I thought I'd share it here to make sure I'm thinking correctly and my conclusions are right. In this example I've assumed ex-divi date = payment date just to keep it simple. And the funds assets are static in value.

01JAN £100k in fund invested in companies paying £5000 Divis (100 units)
31JAN £2000 of those divs have been paid (40%)
01FEB £100k added to fund and invested...
Fund now £200k paying £10000 Divis (200 units)
31MAR Other 60% of divis have been paid = 0.6 x 10000 = £6000

Total Dividend = 2000 + 6000 = £8000

shared between 200 units = £40
Without inflow = 5000 / 100 = £50

So it seems that inflows reduce the next dividend payment and hence outflows I assume increase it. I think I understand that there is no unfairness going on as the prices paid buying the assets pre or post ex-divi date equalize it all out. I just wonder how much volatility in the payment for inc units is added.

I'm mostly just curious to understand it all but I'm also specifically thinking about the Woodford income focus. Thinking I may be better of waiting until the main inflows have happened before I buy in. Worried there might be a wait for the income boost vs his other funds lower divi I'll be selling.

[Alaric]

I was thinking about how inflows and outflows of cash could effect the divi payments and really struggling to get my head around it.

The way the accounting and pricing rules work should mean there's no effect from the timing of cash flows provided they are always in the same direction. That's to do with spread rather than timing. In constructing examples you shouldn't assume that asset prices aren't themselves affected by the timing of dividends. So if you buy a package of shares on 1st January and 20% of them pay a dividend on 31st Jan, the prices of the shares that have paid the dividends aren't the same as those that haven't. The other complication is that the pricing of the units may include dividend income accrued but not yet paid.

What OIECs do with dividends is that they accumulate them for a half year or so and then distribute them in one go. When you buy shares you get the same dividend whether or not you bought them just before the dividend payment or six months earlier. So it shouldn't matter to the new Woodford fund when it gets investors' money.

[mc2fool]

01JAN £100k in fund invested in companies paying £5000 Divis (100 units)
31JAN £2000 of those divs have been paid (40%)
01FEB £100k added to fund and invested...
Fund now £200k paying £10000 Divis (200 units)
31MAR Other 60% of divis have been paid = 0.6 x 10000 = £6000

Ummm ... there's so much wrong with this example that it's difficult to know where to begin

Firstly, OEICs don't hold reserves, so they pay out all of the dividends they received since they last paid out (six months ago, three months ago, one month ago, or whatever their payout frequency is), so your first four lines should read:

01JAN £100k in fund invested in companies expected to pay £5000 Divis in the next year (from 1 Jan) (100 units)
31JAN £2000 of those divs now received from those companies, of which 100% are paid out.
01FEB £100k added to fund and invested...
Fund now £200k invested in companies expected to pay £10000 Divis in the next year (from 1 Feb) (200 units)

Now, the problem with your 31 Mar line is that you are applying the 60%, being the remainder of the amount expected from the first £100K, to the £200K, which is the first £100K plus the later £100K, without taking into account the different holding periods in your conclusion.

If the companies did indeed have a 40%/60% split between their interim dividends in Jan and (highly unusually) their final dividends in Feb/Mar, then at 31 Mar they'd pay £6000 to the OEIC, which would distribute £3000 to the first £100K investors and the other £3000 to the second £100K investors, so...

Holders since 1 Jan will have received (£2000+£3000) / 100 units = £50 per unit, and
Holders only since 1 Feb will have received £3000 / 100 units = £30 per unit

Both will, if still holders then, (expect to) receive a further £20 per unit the following 31 Jan, so everybody will receive £50 per unit per annum of holding.

[nmdhqbc]

Ummm ... there's so much wrong with this example that it's difficult to know where to begin

And you broke it to me so gently. Very kind.

Firstly, OEICs don't hold reserves, so they pay out all of the dividends they received since they last paid out (six months ago, three months ago, one month ago, or whatever their payout frequency is),

Yeah, I did / do know this. I forgot to include vital info in my example. I meant for this to be a quarterly paying fund and I was going through the first 3 months dividends and see how a big inflow a month in effects it. So that £2k of dividends in my example (in my head anyway) was not being actually paid until the end of the 3 months so it would go to both sets of fund holders. I now also realize the yield would be ridiculously high so I'll adjust.

Thanks for pointing out the errors. I'll try again. Hopefully this one is closer to making sense...

01JAN £400k in fund invested in companies paying £5000 Divis in Jan-Mar to be paid in one divi (400 units)
31JAN £2000 of those divs have been paid (40%) into fund but not yet to fund unit holders.
01FEB £400k added to fund and invested...
Fund now £800k paying what would have been £10000 Divis Jan-Mar (800 units) but...
40% of these have already been paid so 60% will be paid up to 31MAR = 0.6 x 10000 = £6000

Total Dividend = 2000 + 6000 = £8000

shared between 800 units = 8000 / 800 = £10
Without inflow = 5000 / 400 = £12.50

As I said earlier, I've purposely simplified and I know it's not a realistic example. I also get that the prices adjust when shares and the fund itself goes ex-dividends. So I get that overall there's no winners or loser. I'm thinking it may just be a re-jig of a higher unit price making up for a possible lower divi payout for the inc holders. Unless that is there's some clever adjustment made to stop my example being so.

[genou]

I'm thinking it may just be a re-jig of a higher unit price making up for a possible lower divi payout for the inc holders. Unless that is there's some clever adjustment made to stop my example being so.

Where is the equalisation payment in your scenario?

[mc2fool]

Unless that is there's some clever adjustment made to stop my example being so.

Broken with warmth and good humour at least

This might help: https://www.willisowen.co.uk/help/equal ... -explained

[nmdhqbc]

Where is the equalisation payment in your scenario?

Unless that is there's some clever adjustment made to stop my example being so.

Broken with warmth and good humour at least

This might help: https://www.willisowen.co.uk/help/equal ... -explained

genou's post had already led me to Google which led me to this exact page. I did come across it when filling in my last tax return. It's was my understanding that this would split the first dividend payment into capital gain and divi income for tax purposes only. I couldn't garner the answer to this from the article - Is this cash segregated upon entering the fund and not invested? If so I guess they would know how much of that days NAV is made up of the dividend accumulated since the last ex-divi date and not invest that amount but rather use it to supplement the next dividend. Am I getting there? If so I'll see if I can adjust my example to try and cement my understanding.

Thanks for all the help, I really like to get to understand the nitty gritty of these things.

[nmdhqbc]

I went ahead and did it anyway. Is this how it would work....

01JAN £400k in fund invested in companies paying £5000 Divis in Jan-Mar to be paid in one divi (400 units)
31JAN £2000 of those divs have been paid (40%) into fund but not yet to fund unit holders.
01FEB £400k added to fund and £398k invested... (£2000 set aside for next divi = Equalisation)
Fund now £800k paying what would have been £10000 Divis Jan-Mar (800 units) but...
40% of these have already been paid so 60% will be paid up to 31MAR = 0.6 x 10000 = £6000

Total Dividend = 2000 (Jan divis) + 2000 (Equal. Payment) + 6000 (Feb/Mar Divis) = £10000

shared between 800 units = 10000 / 800 = £12.50
Without inflow = 5000 / 400 = £12.50

[Alaric]

Is this cash segregated upon entering the fund and not invested?

If needed they would keep a record for accounting and reporting purposes. Otherwise it would just disappear into the general liquidity of the fund. With an open ended fund, there's always a possible day when outflow exceeds income, so managers may maintain a variable cash float to avoid the need to incur transaction costs with a sale.

[nmdhqbc]

If needed they would keep a record for accounting and reporting purposes. Otherwise it would just disappear into the general liquidity of the fund. With an open ended fund, there's always a possible day when outflow exceeds income, so managers may maintain a variable cash float to avoid the need to incur transaction costs with a sale.

OK, so I guess the question is... is the equalization payment paid back in the first dividend as well as the dividends received? Or are the fund unit holders only paid dividends? I don't want to influence your answer but the former would have me understanding it all and the latter still leaves me confused.

[Alaric]

Or are the fund unit holders only paid dividends?

If the fund has x units and pays a dividend of y per unit, the total dividend payment is x*y. I believe that way that equalisation works is that on the first dividend statement for a new unit holder, the payment is displayed as two parts, one being a proportion of the dividend for the length of time the unit holder has been invested ("dividend") and the balance of the payment ("equalisation"). It doesn't do anything other than clarify how the recipient should report the payment for tax purposes.

Any taxation system that didn't involve an element of accrual would be vulnerable to tax arbitrage where the tax rules for gains differed from those for income.

Another way of looking at this is to suppose that the fund has the same number of units throughout, but during the reporting period, some unit holders have bought in and others have left. The total dividend payable is unaffected, but the leavers may have achieved a higher price by leaving without taking their dividend, whilst some of the price for joiners reflects a purchase of the next future dividend.

[mc2fool]

OK, so I guess the question is... is the equalization payment paid back in the first dividend as well as the dividends received?

Unless you happened to invest exactly on the XD date or the day before, then your first payout from the fund will consist of an equalisation payment plus a part of the dividends they have received since they last paid out. The closer you were to the previous XD date when you made your investment the more it will be dividends and the less equalisation (capital), and the closer you were to the next XD date the more it will be equalisation (capital) and the less dividends.

If you invested the day before the XD date it will be entirely capital and if you invested on the XD date it will be entirely dividends.

[nmdhqbc]

Or are the fund unit holders only paid dividends?

If the fund has x units and pays a dividend of y per unit, the total dividend payment is x*y. I believe that way that equalisation works is that on the first dividend statement for a new unit holder, the payment is displayed as two parts, one being a proportion of the dividend for the length of time the unit holder has been invested ("dividend") and the balance of the payment ("equalisation"). It doesn't do anything other than clarify how the recipient should report the payment for tax purposes.

Any taxation system that didn't involve an element of accrual would be vulnerable to tax arbitrage where the tax rules for gains differed from those for income.

Another way of looking at this is to suppose that the fund has the same number of units throughout, but during the reporting period, some unit holders have bought in and others have left. The total dividend payable is unaffected, but the leavers may have achieved a higher price by leaving without taking their dividend, whilst some of the price for joiners reflects a purchase of the next future dividend.

OK, so I have to admit I do struggle to understand complex matters from words and I'm struggling here. I'm much better with examples with numbers. Of my former or latter question I think you have answered former here but I'm not sure. Maybe former and latter were incorrect or not clear. Is there any chance you could look at the two scenarios I outlined above (I'll repeat them below) and let me know which is correct? Or if it's neither maybe correct one of them? I just think it would be the quickest and clearest way to get the message across to someone as slow as I am.

Scenario 1:
01JAN £400k in fund invested in companies paying £5000 Divis in Jan-Mar to be paid in one divi (400 units)
31JAN £2000 of those divs have been paid (40%) into fund but not yet to fund unit holders.
01FEB £400k added to fund and invested...
Fund now £800k paying what would have been £10000 Divis Jan-Mar (800 units) but...
40% of these have already been paid so 60% will be paid up to 31MAR = 0.6 x 10000 = £6000

Total Dividend = 2000 + 6000 = £8000

shared between 800 units = 8000 / 800 = £10
Without inflow = 5000 / 400 = £12.50


Scenario 2:
01JAN £400k in fund invested in companies paying £5000 Divis in Jan-Mar to be paid in one divi (400 units)
31JAN £2000 of those divs have been paid (40%) into fund but not yet to fund unit holders.
01FEB £400k added to fund and £398k invested... (£2000 set aside for next divi = Equalisation)
Fund now £800k paying what would have been £10000 Divis Jan-Mar (800 units) but...
40% of these have already been paid so 60% will be paid up to 31MAR = 0.6 x 10000 = £6000

Total Dividend = 2000 (Jan divis) + 2000 (Equal. Payment) + 6000 (Feb/Mar Divis) = £10000

shared between 800 units = 10000 / 800 = £12.50
Without inflow = 5000 / 400 = £12.50

[nmdhqbc]

OK, so I guess the question is... is the equalization payment paid back in the first dividend as well as the dividends received?

Unless you happened to invest exactly on the XD date or the day before, then your first payout from the fund will consist of an equalisation payment plus a part of the dividends they have received since they last paid out. The closer you were to the previous XD date when you made your investment the more it will be dividends and the less equalisation (capital), and the closer you were to the next XD date the more it will be equalisation (capital) and the less dividends.

If you invested the day before the XD date it will be entirely capital and if you invested on the XD date it will be entirely dividends.

OK, I'm sorry to be so slow but I think you are saying that Scenario 2 (in my last post) is correct? As I said there I struggle with words. I THINK (could well be wrong) I have mc2fool saying Scenario 2 is correct and Alaric saying Scenario 1 is correct. Is that right guys or are both wrong?

[mc2fool]

OK, I'm sorry to be so slow but I think you are saying that Scenario 2 (in my last post) is correct? As I said there I struggle with words. I THINK (could well be wrong) I have mc2fool saying Scenario 2 is correct and Alaric saying Scenario 1 is correct. Is that right guys or are both wrong?

I don't think we're saying different things: I read Alaric as also saying that everyone gets the same dividend per unit, regardless of cashflows (scenario 2), with the only effect being, as he said, on taxation. And I think you'll find that confirmed in https://www.willisowen.co.uk/help/equal ... -explained

However, we (and that page) are talking about it from the investors point of view, whereas you seem to be asking how it all works inside the fund.

We do have a resident open ended fund manager here: Rob, can you enlighten nmdhqbc in this?

[tjh290633]

OK, so I have to admit I do struggle to understand complex matters from words and I'm struggling here. I'm much better with examples with numbers. Of my former or latter question I think you have answered former here but I'm not sure. Maybe former and latter were incorrect or not clear. Is there any chance you could look at the two scenarios I outlined above (I'll repeat them below) and let me know which is correct? Or if it's neither maybe correct one of them? I just think it would be the quickest and clearest way to get the message across to someone as slow as I am.

Scenario 1:
01JAN £400k in fund invested in companies paying £5000 Divis in Jan-Mar to be paid in one divi (400 units)
31JAN £2000 of those divs have been paid (40%) into fund but not yet to fund unit holders.
01FEB £400k added to fund and invested...
Fund now £800k paying what would have been £10000 Divis Jan-Mar (800 units) but...
40% of these have already been paid so 60% will be paid up to 31MAR = 0.6 x 10000 = £6000

Total Dividend = 2000 + 6000 = £8000

shared between 800 units = 8000 / 800 = £10
Without inflow = 5000 / 400 = £12.50


Scenario 2:
01JAN £400k in fund invested in companies paying £5000 Divis in Jan-Mar to be paid in one divi (400 units)
31JAN £2000 of those divs have been paid (40%) into fund but not yet to fund unit holders.
01FEB £400k added to fund and £398k invested... (£2000 set aside for next divi = Equalisation)
Fund now £800k paying what would have been £10000 Divis Jan-Mar (800 units) but...
40% of these have already been paid so 60% will be paid up to 31MAR = 0.6 x 10000 = £6000

Total Dividend = 2000 (Jan divis) + 2000 (Equal. Payment) + 6000 (Feb/Mar Divis) = £10000

shared between 800 units = 10000 / 800 = £12.50
Without inflow = 5000 / 400 = £12.50

Your trouble is that you are thinking in money rather than in units.

Look at it like this:

01-Jan: 400,000 units are bought at £1 each. Dividends are expected to be 125p/unit, i.e. £5,000, split 0.5p interim and 0.75p final.

31-Jan: The units go XD for the interim to be paid at 0,5p on 400,000 units, i.e. £2,000.

01-Feb: a further 400,000 units are bought at £0.995 each, ex-dividend and are not entitled to the interim dividend of 0.5p.

31-Jul: The units go XD for the final to be paid on all 800,000 units at 0.75p, i.e. £6,000

Had you not bought the second tranche of units, you would only have received £3,000.

Your problem is adding equalisation, which does not apply once the units have gone XD. It is applied to all shares bought between the two ex-dividend dates, but is applied equally to make taxation easier. If they were shares, then you would not have to worry about it.

TJH

[nmdhqbc]

I read Alaric as also saying that everyone gets the same dividend per unit, regardless of cashflows (scenario 2)

Oh heck, I think we may be talking about 2 different things here... I'm not talking about each investor getting the same or different dividend. Of course each unit holder get the same. It's a question of how high that dividend is and whether a big inflow will reduce it (scenario 1) or will it stay the same (Scenario 2). I'm obviously not a great communicator so don't worry if you want to bail out due to frustration.

[tjh290633]

Oh heck, I think we may be talking about 2 different things here... I'm not talking about each investor getting the same or different dividend. Of course each unit holder get the same. It's a question of how high that dividend is and whether a big inflow will reduce it (scenario 1) or will it stay the same (Scenario 2). I'm obviously not a great communicator so don't worry if you want to bail out due to frustration.

Where does that inflow come from? Outer space?

If the fund suddenly receives a lot of subscriptions, and so has to create a lot of new units, then it has to find new investments to soak up the new money, and the dividends will depend on what those new investments will pay. They are unlikely to be the same as the original investments.

TJH

[nmdhqbc]

Where does that inflow come from? Outer space?

If the fund suddenly receives a lot of subscriptions, and so has to create a lot of new units, then it has to find new investments to soak up the new money, and the dividends will depend on what those new investments will pay. They are unlikely to be the same as the original investments.

Exactly as you said - new subscriptions. And I guess this is another unrealistic oversimplification we can add the the example for the purposes of understanding it. The new funds buy exactly the same assets as the first half.

[tjh290633]

Where does that inflow come from? Outer space?

If the fund suddenly receives a lot of subscriptions, and so has to create a lot of new units, then it has to find new investments to soak up the new money, and the dividends will depend on what those new investments will pay. They are unlikely to be the same as the original investments.

Exactly as you said - new subscriptions. And I guess this is another unrealistic oversimplification we can add the the example for the purposes of understanding it. The new funds buy exactly the same assets as the first half.

In that case my post above stands, except that the word "bought" should be replaced with "created".

TJH