Fund Distributions and Portfolio Returns
At the end of every year, mutual funds distribute capital gains and dividends. Looking at any part of the portfolio in isolation can cause confusion, and this is especially true when reviewing account statements around distribution dates. Merely looking at the change in a fund’s net asset value (NAV), or the difference between the cost basis and the current value of the investment, does not necessarily represent the returns of the fund or the portfolio.
Fund NAV Around Distributions
Before discussing the impact of a distribution, we should first understand how a fund company calculates a mutual fund’s NAV. The NAV is calculated by dividing the total value of the fund’s assets by the number of fund shares outstanding. The fund’s assets include positions such as individual equities, bonds, futures and exchange-traded funds plus any cash the fund holds. As a fund approaches a distribution, the portfolio manager will move more money to cash to prepare for the payout. When the fund makes the distribution, the total fund assets decline, leading to a lower NAV.
In the simplified example below, we create a hypothetical fund and show the total value and NAV for the following distribution time frames: 30 days prior, two days prior, one day prior and again on the day of the distribution. We see the fund accumulates cash the day prior to the distribution; the next day, however, the fund’s total assets drop by the amount of the distribution.
In this case, the $7 cash held one day prior to the distribution (Column C) is paid out on the distribution day (Column E). Focusing on Column H, the fund appears to have lost money over the 30-day period since the NAV fell from $10 to $9.90. This, however, isn’t the full story because an investor who held the fund through that time would also receive the $0.70 per share distribution (Column G). Cash left the fund while the number of shares outstanding remained the same, resulting in a drop in the fund NAV.
It’s worth noting that if investors reinvest distributions, it does not change the fund NAV. If we assume all distributions are reinvested in the example above, the mutual fund would have 0.7071 additional shares (calculated as Column E divided by Column H). The total shares would be 10.7071, and if we multiply that by the fund NAV ($9.90), the total assets of $106 equal the total assets plus the distribution.
Changes in Statement Value Vs. Total Return
This raises an important issue — the difference between market value and cost basis is not the return of a fund (or a portfolio). Only in special circumstances will this difference equal the investor’s return. For example, using the hypothetical fund above, let’s assume an investor purchased 40 shares of the fund 30 days prior to the distribution and then holds it through the distribution date.
This is what the statement would look like on the days presented above:
In this case, the statement shows the investor’s cost basis is above the current market value, implying a loss of $4, or 1 percent of the original investment. However, including the income from the distribution, we see the investor has earned $24 as of the pay date (Column P). In other words, this investor’s return over the 30-day period was not a loss of 1 percent, but rather a gain of 6 percent ($424/$400 – 1)! This assumes distributions were paid to cash, but the same mechanics hold when dividends are reinvested.
The Bottom Line
As the examples illustrate, the total return of a portfolio is more complicated than simply comparing the market value of the portfolio to the cost basis. Many factors come into play, including the impact of distributions, reinvestments of dividends and the frequency in which the investor adds to the position. When trying to understand the performance of your portfolio, it’s best to look at the time-weighted return presented in your statements.
As you consider the performance of your portfolio, be sure to focus on what matters most: Are you taking the right amount of risk to meet your goals? Every Wealth Analysis assumes the portfolio will have some bad years (and some very bad years), so losses are no reason to abandon a strategy. We don’t try to time the market to avoid losses. We set an allocation, commit to disciplined rebalancing and then let markets act as they will. Because at the end of the day, what matters most is that you’re able to meet your goals and sleep well at night without having to worry about what the market is doing.
 This applies only if the investor made a single purchase of the fund and the fund has made no distributions.
 We simplify this example by assuming the record date, ex-dividend date and pay date all happen on the day the distribution is paid. It also assumes market values and investment values are flat around the distribution day, and the fund creates no additional shares.
This material is derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Copyright © 2018, The BAM ALLIANCE