Are period distributions in a mutual fund an essential feature of a mutual fund? PRUDENTIAL FUND
MANAGEMENT delves into the process and clarifi es the conundrum
From a Shariah perspective, these realized gains include income from profit, accretion of discounts net of amortization of the amount paid on Sukuk, and dividend income from Shariah compliant share equities. For the sake of simplicity, conventional terms are used in this article.
The need to pay out any distribution is dependent on the unit trust’s objective(s). For unit trusts with the objective of providing a stable income stream, it is intended that distribution be done at a stipulated period, subject to the fund’s income realized for the financial year. Capital appreciating unit trusts, on the other hand, will reinvest the income and capital gains into their investment portfolios. For these funds, distribution is on an ‘incidental’ basis.
A unit trust which does not have realized gains in order to declare a distribution will have to sell some assets held in the fund’s portfolio in order to finance the distribution. Although this is not impossible, if the timing of the sale is unfavorable the value of the unit trust could be affected.
The amount to distribute in the event of a fund distribution is determined by management objectives, and by the amount of income and gains realized. Usually the amount to distribute would be competitive; with fixed deposit rates, yields of government securities and other risk-free rates.
The frequency of the distribution is stated in the prospectus of the unit trust. Common distribution frequencies include monthly, quarterly, semi-annually and annually.
The calculation of a distribution is based on the number of units in circulation at the close of business of a selected day, known as the entitlement date. The date when the distribution is effected is the ex-date. The dividend reinvestment date is the date the distribution is reinvested into the unit trust; the close of business of a ‘grace period’ for the investor to give instruction with regards to the distribution. If no instruction is received from the investor, the distribution is automatically reinvested to the fund. Investors who opt to receive the distribution instead, will receive it in a form of a cheque. Distributions are usually paid within a period of one month from the date of declaration.
To illustrate, we will use the specifics of a recent distribution by Prudential Fund Management for the PRUdana al-ilham: see Table 1.
Following the distribution, the NAV and price of the fund usually drops as the capital of the fund is diluted.
Investors who invest in the unit trust before the ex-date will receive the distribution but face a significant drop in the NAV, post distribution.
Investors who have a medium to long-term investment horizon will benefit from a distribution if they reinvest the distribution and remain invested in the unit trust. In effect, they will have more units post-distribution. When the NAV of the unit trust rises to a favorable level and the investor takes profit on the investment, his profit is relatively higher as there are more units in his investment portfolio.
In Malaysia, distributions are taxed at a resident corporate rate of 25%. Fund distributions are also known as dividends declared, and under the Malaysian single-tier tax system these dividends are taxed at corporate level. To avoid double taxation of a distribution, investors will receive a tax credit form. Eligible investors must then submit the tax credit when filing their annual personal income tax to avoid being taxed twice for their dividend received.
There are costs involved in declaring a distribution for any unit trust company. However, these additional costs are insignificant compared to the intrinsic value of meeting the investment objectives of the unit trust and keeping investors happy.
Some unit trust companies do see income distribution as a strategy to draw more investors; as regular distributions can portray that the fund is performing well, even though it may not be necessarily so.