Exchange traded funds (ETFs) and closed-end funds (CEFs) are composed of many different individual securities. This usually results in uneven dividend distributions. Some funds have tried to address this with a managed distribution policy. In short, a managed distribution policy is management’s commitment to make a fixed periodic dividend payment.
How Managed Distribution Policies Work
Since many funds distribute most of their income to shareholders in order to avoid taxation, funds with a managed distribution policy sometimes have cash left over at year-end that needs to be distributed. This is is normally done as a “special” one-time dividend. However, if the fund generates insufficient cash to cover the dividend, the fund is forced to sell some investments to cover the cash short-fall. In turn, this portion of the short-fall is treated as a return of capital and the fund now has lower assets to generate future income.
Advantages of Managed Distribution Policies
According to a Gabelli Funds report, managed distribution policies offer several advantages, including:
1. Lower difference between the fund’s market price and its NAV per share.
2. Provides support during periods when the stock market is in a decline.
3. Provides a measurable performance target for the investment adviser.
Below are several high-yield funds from CEFA that have a managed distribution policy (yields as of August 31):
Aberdeen Australia Eqty (IAF)
- Distribution Yield: 9.25%
- Income Yield: 3.41%
BlackRock En Capital&Inc (CII)
- Distribution Yield: 13.50%
- Income Yield: 2.16%
Chartwell Div & Inc (CWF)
- Distribution Yield: 10.62%
- Income Yield: 4.71%
Cornerstone Strat Value (CLM)
- Distribution Yield: 17.09%
- Income Yield: 0.79%
Cornerstone Total Return (CRF)
- Distribution Yield: 16.81%
- Income Yield: 0.00%
Delaware Inv Gl Div & Inc (DGF)
- Distribution Yield: 10.00%
- Income Yield: 4.17%
Gabelli Equity Trust (GAB)
- Distribution Yield: 11.95%
- Income Yield: 1.53%
Gabelli Utility Trust (GUT)
- Distribution Yield: 12.90%
- Income Yield: 3.68%
Zweig Fund (ZF)
- Distribution Yield: 12.47%
- Income Yield: 0.66%
As noted in the Gabelli report, a managed distribution policy may create confusion regarding the true current yield since the reported yield includes the return of capital portion. You can see the disparity above between the income yield and the distribution (reported) yield.
If you are looking for a sustainable and growing dividend, you may want to consider some blue-chip dividend stocks such as these with a Free Cash Flow Payout less than 50%:
|T. Rowe Price (TROW)||2.14%||15.00%||41.48%|
|Abbott Labs (ABT)||3.31%||8.27%||37.94%|
|Wal-Mart Stores (WMT)||2.24%||11.01%||36.30%|
|RPM International (RPM)||4.11%||3.16%||36.06%|
|Harleysville Grp (HGIC)||4.22%||8.00%||34.72%|
|Procter & Gamble (PG)||3.13%||6.96%||31.30%|
|Leggett & Platt (LEG)||4.65%||2.96%||29.91%|
|Medtronic Inc. (MDT)||2.66%||9.40%||27.88%|
|Owens & Minor (OMI)||2.51%||15.12%||22.22%|
|Weyco Group (WEYS)||2.55%||15.00%||21.60%|
When investing in a fund with a managed distribution policy, it is important not to confuse predictable cash flows with assured cash flows. A managed distribution policy means that the funds management is making an attempt to smooth out cash flows, but there is no guarantee they will be successful.
Full Disclosure: Long JNJ, CL, ABT, WMT, HGIC, PG, LEG, MDT. See a list of all my income holdings here.
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