Reduced Fund Payout Is Good But Beware of Unsavoury Sales Pitch

I recently wrote about how high-payout monthly income funds are being mis-sold to investors and how some fund companies had provided false and misleading information to at least one end investor.  I always take notice of fund distribution cuts so a recent announcement caught my attention.  While the announced distribution cut is good news (because it addresses sustainability) it comes with a warning for investors.

Distribution more than halved

This week Sentry Investments announced many changes to its funds, which included slicing Sentry Growth & Income fund’s monthly payout from $0.067 per unit to $0.032 starting in January – a 52% drop.  This fund landed on my radar this past spring, at which point I estimated that its distribution would need to fall by 46% (to $0.0357 monthly per unit) in order to be sustainable.

But delaying the decision over the past several months – during which the unit price dropped by 10 per cent – simply exacerbated a clearly unsustainable payout.  The delay necessitates a more severe distribution cut than would have been necessary had they done it sooner.

Since nearly 40% of distributions have been taken in cash over the past couple of years, this fund’s investors will feel the pinch of reduced cash flow.  The pain will be compounded for those who invested in the fund with borrowed money – which is too common with high payout funds.

Beware the potential sleight of hand

A minority of advisors will likely tell clients not to worry that their fund’s payout will soon fall by more than half – because they can switch into the new version (Sentry Growth and Income T8 in this case) which will target an 8% annualized cash distribution.  And anybody hearing this pitch needs to step back and think.

After several years of strong market returns, Sentry Growth and Income couldn’t sustain its 8% payout.  Now Sentry thinks it’s prudent to cut the distribution because it can’t be supported in the future.  But then why launch another version of the same fund with the same distribution that they’ve just admitted can’t be sustained?

The answer is that funds with high cash distributions are an easy sell.  Sentry’s new T8 version will launch at $10 per unit so it will ‘look good’.  And it will take some time before this new fund is also forced to start slicing its payout – which I think it will in time.  Sadly Sentry isn’t alone.  BMO, IA Clarington and Mackenzie are among those who have done exactly the same thing.

This behaviour is shameful because it is focused on creating investment products designed to attract money from investors who are desperately seeking yield in a world with chronically-low interest rates.  I’m waiting for a new sweeping trend whereby fund companies remain focused on the prudent investment management principles that built their businesses; and stop launching gimmicky and unsustainable products just to gather more assets.  But after 14 years of writing on this topic I’m not holding my breath.

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