Mutual fund share split

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A mutual fund share split occurs when a mutual fund company issues additional shares to its existing shareholders.[1][2] A reverse share split occurs when a fund company decides to decrease the number of shares held by its existing shareholders.[3]

Share splits

A share split is often done by splitting the existing shares into multiple shares. This lowers the value of each share by the amount of the split. A 4-for-1 stock split replaces each share owned with 4 shares and each share is now worth 1/4th of what it was before the split. The net value of the shareholder's account does not change. The table below shows the resulting number of shares owned, the hypothetical net asset value, and the value of shares, assuming a 4-for-1 share split.

# of Shares Owned Hypothetical NAV Value of Shares
Pre-Split 100 $40.00 $4,000.00
Post-Split 400 $10.00 $4,000.00

To properly account for the tax cost basis after a mutual fund share split:

  • Increase your position by the stock split rate on the Ex-Dividend Date
  • Maintain your original total cost
  • Maintain your original holding period
  • Decrease your cost per share (to three decimal places, e.g. a $24.25 cost per share to a $12.125 cost per share in a 2-for-1 split)[4]

Share split rationale

Critics of mutual fund share splits argue that the underlying economic position of a shareholder is unchanged by a share split, and that fund companies use the procedure for marketing purposes. Marketing purposes include reducing a fund's high net asset value to a level more in line with current fund offerings[5][6], and to increase fund sales. A Wharton study on mutual fund share splits concludes:

We find that mutual funds that do split experience significant post-split increases in net asset inflow and the number of shareholders. Our findings suggest that fund managers use splits to attract new money, and that fund managers regard splits as enhancing the marketability of mutual fund shares.[7]

Reverse share splits

A reverse share split is the opposite of a share split. A reverse split occurs when a fund company decides to decrease the number of fund shares by combining the existing shares into fewer shares. This increases the per share value of the share. A 1-for-5 reverse stock split replaces each 5 shares owned with 1 share and each share is now worth 5 times what it was before the reverse split. The net value of the shareholder's account does not change. The table below shows the resulting number of shares owned, the hypothetical net asset value, and the value of shares, assuming a 1-for-5 reverse share split.

# of Shares Owned Hypothetical NAV Value of Shares
Pre-Split 1000 $6.00 $6,000.00
Post-Split 200 $30.00 $6,000.00

To properly account for the tax cost basis after a mutual fund reverse share split:

  • Decrease your position by the stock split rate on Ex-Dividend Date
  • Maintain your original total cost
  • Maintain your original holding period
  • Increase your cost per share (to three decimal places)

Reverse share split rationale

Reverse share splits are more frequent with exchange-traded funds (ETFs). The rationale for reverse splits include the following:

  • To maintain listing on an exchange: An exchange generally specifies a minimum bid price for a stock to be listed. If the stock falls below this bid price, it risks being delisted.[8]
  • To lower shareholder transaction costs when buying and selling the ETF. The higher price is expected to reduce bid/ask spreads.[3]

A special case

American Century offers investors a series of mutual funds that invest in zero coupon treasury bonds. The funds terminate at an expected value when the zero treasury bond matures. When any fund pays a distribution (the IRS requires investors to pay annual taxes on interest accrual) it causes the share price to fall by the distribution amount on the distribution date. In order for the Zero Coupon fund(s) to reach their anticipated share value by its target year, a reverse share split is necessary. This allows the fund(s) to distribute a dividend and any capital gains without decreasing the share price.[9]

Mutual fund share conversions

Mutual fund companies often offer various share classes for a specific mutual fund. Investors reaching certain milestones, such as total amount invested in the fund or length of time the shares have been held, frequently qualify for a conversion to lower cost shares. The conversion often takes place at differing net asset values, so the number of shares held after conversion will be different, although the value of the investor's account is unchanged.

Examples of such conversions include:

  • The conversion of B-shares to A-shares for load-fund mutual fund offerings;
  • The conversion of shares with higher expense ratios for shares with lower expense ratios (Vanguard admiral shares and Fidelity advantage class shares are examples of shares with lower expense ratios). Note that if the amount invested falls below a required minimum, a conversion of lower expense shares for higher expense shares can take place;
  • At Vanguard, the conversion of an index mutual fund into the fund's exchange-traded fund share class.

References

  1. ProFunds Announces Mutual Fund Share Splits - Yahoo Finance, viewed 12 January 2015.
  2. Guggenheim share splits, viewed 12 January 2015.
  3. 3.0 3.1 Vanguard Announces Reverse Share Split for Exchange-Traded Fund, viewed 12 January 2015.
  4. Gainskeeper: Splits, viewed 13 January 2015.
  5. Do mutual funds ever split there shares, Dagen McDowell, thestreet.com. 01/20/99, viewed 12 January 2015.
  6. No value, only gimmickry when fund shares are split, Charles A. Jaffe, The Baltimore Sun, October 24, 1999, viewed 12 January 2015.
  7. Fernando, Chitru S. and Krishnamurthy, Srinivasan and Spindt, Paul A., Is Share Price Related to Marketability? Evidence from Mutual Fund Share Splits, (August 1999). 97-06. Available at SSRN.
  8. Reverse stock split, investopedia, viewed 12 January, 2015
  9. Why do a reverse split?, American Century Investments, viewed 12 January 2015.

External links