Mgmt fees & distributions: Bond Funds v. Equity Funds

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
troysapp
Posts: 56
Joined: Fri Mar 25, 2011 6:08 pm

Mgmt fees & distributions: Bond Funds v. Equity Funds

Post by troysapp »

In a recent thread I noticed what seemed to be confusion about how mutual fund distributions and management fees work. I’ve 14 years’ experience with accounting, compliance, tax prep, shareholder reporting, shareholder distributions, etc. with four 1940 Act Funds, so I thought I’d attempt to shed light on how Fund distributions and expenses work.

Management fees
Management fees work the same for both bond and equity funds. At the end of each day a Fund’s management fee is calculated with the following equation:

(Net Asset Value x Management Fee Rate)/365 days = management fee for the day

The result of this equation is then booked as a fund expense and a payable each day. The management fee payable is generally paid either monthly or quarterly.

Distributions to Shareholders
Distributions from bond funds (including money market funds) and equity funds differ.

Bond Funds:
Typically, bond fund distributions are declared daily and payable monthly. This is why a shareholder that redeems a bond fund mid-month will receive a residual distribution at month end.

Typically, a daily bond fund distribution calculation goes something like this: (Accrued Interest for the day + Accretion of Bond Discounts for the day – Amortization of Bond Premiums for the day – Daily Management Fee Accrual for the day – Other Expenses for the day)/Daily dividend shares = Per Share Dividend Accrual Payable at Month-End.

The Daily Dividend Accrual for bond funds is then booked as a distribution to shareholders and a payable. The payable is then paid at the end of each month.

This should make sense since the holder of a bond also accrues interest each day.

Equity Funds:
Distributions tend to be declared occasionally throughout the year (e.g., quarterly, at year-end, etc.). For both Bond Funds and Equity Funds, the fund must pay out at least 98% of its realized net income and/or gains during the year (though a few days are granted after the end of the year which is why you’ll sometimes see Vanguard pay prior year distributions on Jan 2 or 3 of the following year).

If a fund does not pay at least 98% of its net income and gains, then the Fund will be subject to excise tax. (Funds must also pay out residual net income/gains within the 365 days following the close of the Fund’s year or be subject to excise tax on that amount as well). Each year the Fund accountants estimate net income and/or gains for the Fund Trustees. The Trustees then approved the distribution. Most times, though, actual net income and/or gains are difficult to accurately determine. This is mainly due to REITs, year-end trading, and foreign holdings. Therefore the Fund accountants will often round up their calculations as a cushion against excise tax. Further, until a Fund has been audited, it tax return is prepared, its tax provision reconciled, and underlying investment reporting has been received; accurate 1099s are often not possible. The inaccuracy of 1099s does not preclude the Jan 31 deadline for sending out 1099s, however. This is why amended 1099s are often sent for foreign funds (REIT discrepancies can usually be adjusted for in subsequent periods). This rounding up often results in a Return of Capital. Generally, Funds would rather not make a Return of Capital distribution, but they’d rather risk that than pay excise taxes.

Due to dividends being declared occasionally for equity funds (versus daily for bond funds), residual distributions are not made from equity funds like with bond funds.

This should make sense since the owner of a stock does not accrue his dividends each day, but instead dividends are only owed them if/when they hold shares on ex-date/record date.

I also noticed someone say that when an equity fund receives a dividend, the fund’s NAV increases by that dividend. This is true. (but note this is not exactly the case for bond funds since they accrue interest daily)

For example, if a fund has a per share NAV of $10, and it hits an ex-date/record-date to receive a $1 dividend (per mutual fund share) for an underlying holding, then all things being equal the fund’s per share NAV will be $11. If the Fund shareholder then redeems his share he will receive $11/share. If, however, the shareholder waits until the Fund Trustees declare the distribution of the $1 realized dividend (all else being equal) and he holds until the Fund shares ex-date/record date, but liquidates before receiving the distribution, the shareholder will receive $10/share plus a $1 dividend.

This is a very quick rundown of a fairly complicated subject, but I hope it helps.

tl;dr: income/distribution calculations are different for bond funds and equity funds. Bond funds declare dividends each day while equity funds declare them occasionally throughout the year.
User avatar
LadyGeek
Site Admin
Posts: 72004
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Re: Mgmt fees & distributions: Bond Funds v. Equity Funds

Post by LadyGeek »

Excellent post, this should go in the wiki. The closest I could match is an article section on Net Asset Value: Net asset value (Bond funds versus equity funds)

It doesn't really address distributions, though. Do you think it should go here, somewhere else, or should be a stand-alone wiki page? (Anyone is welcome to answer.)

(tl;dr == too long, didn't read)
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
User avatar
LadyGeek
Site Admin
Posts: 72004
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Re: Mgmt fees & distributions: Bond Funds v. Equity Funds

Post by LadyGeek »

I transcribed the OP's post into a stand-alone wiki article. See: Management fees and fund distributions

Can someone please review? What additional content is needed?

Comments / questions / concerns are welcome.
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
EyeDee
Posts: 1354
Joined: Tue Feb 20, 2007 12:15 am

Re: Mgmt fees & distributions: Bond Funds v. Equity Funds

Post by EyeDee »

LadyGeek wrote:I transcribed the OP's post into a stand-alone wiki article. See: Management fees and fund distributions

Can someone please review? What additional content is needed?

Comments / questions / concerns are welcome.
.

Looks good.

I added a note concerning a notable exception for Vanguard's Inflation-Protected bond funds.
Randy
More Please
Posts: 174
Joined: Mon Jan 31, 2011 10:13 am

Re: Mgmt fees & distributions: Bond Funds v. Equity Funds

Post by More Please »

A very helpful and clearly written post. Thanks!!
User avatar
LadyGeek
Site Admin
Posts: 72004
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Re: Mgmt fees & distributions: Bond Funds v. Equity Funds

Post by LadyGeek »

EyeDee wrote:Looks good.
It's already gone through a few more updates. :) The View history tab will show the changes.

Wiki article link: Management fees and fund distributions

On the management fees, what happens in a leap year? Is it like the Day count conventions used for bonds (365 regardless)? Or, actual days in a year?

I suspect it's actual, but I want to be sure.
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
User avatar
Barry Barnitz
Wiki Admin
Posts: 3302
Joined: Mon Feb 19, 2007 10:42 pm
Contact:

Re: Mgmt fees & distributions: Bond Funds v. Equity Funds

Post by Barry Barnitz »

Hi:

I have made mostly minor wordsmithing and stylistic edits:

1. Fixed capitalization to conform to wiki styling;
2. Reordered some textual elements (excise tax and rounding of distributions) so that they are consolidated;
3. Mentioned that Vanguard refers to post year distributions as "supplemental distributions";
4. Minor syntax changes

regards,
Additional administrative tasks: Financial Page bogleheads.org. blog; finiki the Canadian wiki; The Bogle Center for Financial Literacy site; La Guía Bogleheads® España site.
Post Reply