Management fees and fund distributions

This article describes the overall process for calculating fund management fees and distributions to shareholders.

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:

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:

The Daily Dividend Accrual for bond funds is then booked as a distribution to shareholders and as 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
Equity fund 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 or the fund will be subject to an excise tax (although a few days are granted after the end of the year, which is why Vanguard sometimes pays prior year distributions on January 2 or 3 of the following year. These dividends are usually described as "supplemental dividends"). Funds must also pay out residual net income/gains within 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 approve 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. 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.

Furthermore, accurate 1099s are often not possible until a fund has been audited, its tax return prepared, its tax provision reconciled, and its underlying investment reporting has been received.
 * 1099 forms

However, the inaccuracy of 1099s does not preclude the January 31 deadline for sending out 1099s. This is why amended 1099s are often sent for foreign funds (REIT discrepancies can usually be adjusted for in subsequent periods).

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

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

When an equity fund receives a dividend, the fund’s NAV increases by that dividend. However, 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.