Vanguard funds: distribution methodology

The Vanguard fund distribution articles contain data obtained either directly from the fund's annual report, or derived from the annual report data with assumptions. This article explains the methodology and assumptions used.

Vanguard FTSE All-World ex-US Small-Cap Index Fund Tax Distributions is used as a representative example.

Dividends
Dividends are obtained from the fund's annual report, not the fund's web site. The web site's stated dividend may not appear in the fund's current annual report as explained by Vanguard in its financial statement footnotes:

"Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. Differences may be permanent or temporary. Permanent differences are reclassified among capital accounts in the financial statements to reflect their tax character. Temporary differences arise when certain items of income, expense, gain, or loss are recognized in different periods for financial statement and tax purposes; these differences will reverse at some time in the future. Differences in classification may also result from the treatment of short-term gains as ordinary income for tax purposes."

Translation: If the fund does not have a fiscal year that corresponds with the calendar tax year, the dividend may not correspond with a given fund's December year-end dividend distribution.

For example, a fund may have a fiscal year ending in August 2010 or October 2010. Thus, the reported income reflects any dividend earnings accrued or distributed during the fall of 2009 and the months in 2010 prior to the end of the fiscal year. By law, a fund must distribute all realized income. Therefore, if a fund with an August or October fiscal year (FY) distributes a dividend or a capital gain in December 2010, the dividends and gain will be reflected in the dividends and capital gains in the FY 2011 annual report.

Vanguard's annual report defines Dividend Yield as follows:

Dividend income earned by stocks, expressed as a percentage of the aggregate market value (or of net asset value, for a fund). The yield is determined by dividing the amount of the annual dividends by the aggregate value (or net asset value) at the end of the period. For a fund, the dividend yield is based solely on stock holdings and does not include any income produced by other investments.

Translation: Dividend is actually a yield, and is reported in annual reports as the Ratio of Net Investment Income to Average Net Assets. These reported figures are a permanent record of the long-term history of distributions which, along with other accounting data, can provide insight into the fundamental drivers behind distributions, as well as show the potential for future distributions. Reported yield numbers are convenient when researching for 10-15 years of fund yield data, which are filed in the SEC's EDGAR database.

For example, Vanguard FTSE All-World ex-US Small-Cap Index Fund Investor Shares (VFSVX) made distributions in December 2009. The 2010 fiscal year began on October 31, 2009 so these distributions appear in the 2010 annual report. For corroboration, compare these distributions to the 2010 Certified Shareholder Report:
 * Dividend of $0.31400 on 12/22/2009 matches with Dividends from Net Investment Income (.314)
 * Short Term capital gains (ST Cap Gain) of $0.20900 on 12/22/2009 matches with Distributions from Realized Capital Gains (.209)

The dividend yield is 1.89% (Ratio of Net Investment Income to Average Net Assets).

Funds with a December 31 fiscal year: The per share dividend income and distributed net income figure are usually very close and discrepancies are likely the result of small "supplementary" distributions the funds often make during the early months of the ensuing year.

Capital gains
Capital gains are derived from annual reports, and are calculated by dividing the per share capital gain distribution by the beginning year NAV. In the annual report:


 * Capital gain % = (-Distributions from Realized Capital Gains) / (Net Asset Value, Beginning of Period) * 100%

The distribution is a negative number, as it is used to calculate Net Asset Value.

From the 2010 (VFSVX) Certified Shareholder Report example above, the capital gain is:


 * 0.70% = -(-$0.209) / ($29.83) * 100%

where
 * Distributions from Realized Capital Gains = (.209)
 * Net Asset Value, Beginning of Period = $29.83

Expressing the capital gain distribution as a "yield" allows one to conceptualize the distribution in a consistent, familiar metric similar to the dividend yield percentage (above).

To be completely consistent with yield and expense ratio calculations, an average fund's net assets should be used. Unfortunately, funds do not report an average net asset figure. As a compromise, the best way to estimate capital gain percentage is to divide the per-share capital gain distribution by the beginning year net asset value, as previously described.

Rationale: A fund starts the year with a $10.00 NAV. Over the year, it rises in value by 10% to an $11.00 NAV and distributes a $0.50 capital gain, resulting in a year-end NAV of $10.50. The $0.50 distribution represents a 5.00% gain for the year.


 * 5.0 % capital gain "yield" = $0.50 / $10.00 * 100%

Qualifying Dividends
Qualified Dividend Income (QDI) is listed in the annual report in an unaudited statement following the auditor's report. This lists the total amount of distributed dividends which were QDI in the fiscal year; thus, for a fund with annual distributions and a fiscal year ending before the record date, the QDI will be the amount distributed in the previous calendar year.

The percentage of dividends which are qualified is the ratio of the reported QDI to the reported income distributions. Since short-term gains are reported as non-qualified dividends for tax purposes, the percentage of reported dividends which are qualified is the ratio of the reported QDI to the reported income plus short-term gain distributions.

From the 2010 (VFSVX) Certified Shareholder Report, Special 2010 tax information (unaudited): The fund distributed $2,342,000 of qualified dividend income to shareholders during the fiscal year.

From the Estimated year-end distributions for Vanguard funds: QDI = 74%

Foreign Tax Credit
The foreign tax credit information for the fiscal year is listed in the annual report in an unaudited statement following the auditor's report, which lists the foreign source income and the foreign tax paid. The taxable income realized by the fund is thus the income received plus the foreign tax paid.

The credit per share (assuming that the investor can deduct the entire tax, which most investors can do) can be estimated by:


 * 1) Dividing the foreign tax paid by the total number of fund shares to get the credit per share;
 * 2) Dividing the credit per share by the share price for a share class.

Likewise, the taxable income per share can be estimated by adding the foreign tax credit per share to the reported value of realized income per share.

The numbers in the annual report are the foreign income and foreign tax paid during the fiscal year; this will only correspond to the numbers on an investor's Form 1099 if the fiscal year matches the calendar year.

From the 2010 (VFSVX) Certified Shareholder Report:
 * Net Assets: $804,924,000 (the total fund assets)
 * Special 2010 tax information (unaudited): The fund designates to shareholders foreign source income of $12,638,000 and foreign taxes paid of $1,024,000.
 * Investor Shares—Net Assets, Applicable to 4,680,835 outstanding $.001 par value shares of beneficial interest (unlimited authorization): $170,120,000
 * Investor Shares—Net Assets, Net Asset Value Per Share—Investor Shares: $36.34

Foreign tax credit:
 * $216,422 (Foreign tax paid, Investor share class) = $1,024,000 (Foreign Tax) * $170,120,000 (assets in Investor share class) / $804,924,000 (Net Assets)
 * 0.04624 (Foreign tax / total Investor shares) = $216,422 (Foreign tax paid, Investor share class) / $4,680,835 (total Investor share class)


 * 0.13% (Foreign tax credit) = 0.04624 (Foreign tax / total Investor shares) / $36.34 (Net Asset Value Investor share class) * 100%