Yield/Income Funds Review

This article was originally published in the Investment Funds Practitioner in April 2012.

Staff recently conducted a review of select investment funds which make regular distributions to investors. The scope of this review included the distribution policies and related disclosures as well as the investment fund manager’s decision-making process on the amount and the form of the distributions.   

Our review identified a few key issues. We note that several funds pay distributions which are regularly and significantly in excess of the fund’s increase in NAV from operations, both on an annual basis as well as on a cumulative basis since inception. In these cases, the distributions, in substance, are a return to the investor of their own capital, whereas the use of the terminology ‘yield’ or ‘income’ in the Fund’s name or elsewhere implies underlying performance or earnings to investors. Additionally, cash distributions in excess of earnings deplete the asset base of the fund and can hinder the fund’s ability to meet its other investment objectives.

We further note that some funds typically pay distributions in the form of reinvested units unless, for funds held in non-registered plans, the investor expressly chooses to receive cash distributions. In our view, this default form of distributions (i.e., reinvested units) tends to conflict with the funds’ stated focus of providing investors with a regular income stream. The onus is on investors to expressly advise the fund manager and/or dealer if they want distributions in the form of cash.

Finally, to the extent that investors may be assessing a fund’s performance based on its distribution rates or yield, they may reach incorrect conclusions about their returns on these funds. The fund’s distribution rate or yield is based on its distributions, rather than its earnings or performance.

For these types of funds, staff will ask for the following:

Prospectus Disclosure

• Include prominent disclosure that investor action is needed if distributions in the form of cash are desired. Disclosure should also highlight that if an investor subsequently desires to convert a distribution that has been made in the form of reinvested units into cash, the order of redemption (as specified in the prospectus) would generally result in reinvested units being redeemed last, triggering payment of redemption fees.
• In bold typeface and in plain language, that any distributions made in excess of the fund’s cumulative income generated since the fund’s inception represent a return of the investor’s capital back to the investor.
• Where a distribution or yield is quantified in the prospectus, sales communication or elsewhere (such as a website), the disclosure should specify all of the following:  a) the basis of the calculation, b) the percentage of total distributions comprising reinvested units, c) whether the yield is calculated based on the NAV or market price of the fund’s securities, d) the time period covered by the distributions and the NAV (or market price, as applicable), e) the key assumptions, and f) the impact of changes in key assumptions on the target distribution or yield.
• The form of the distribution (i.e., cash or reinvested units) should be specified whenever a reference to distributions is made (e.g., in the investment objective or elsewhere).

Continuous Disclosure

• When distributions during a period exceed the fund’s earnings from operations during that period, staff expect the fund’s MRFP to discuss why the distribution was made despite insufficient earnings. Further, in case of a shortfall between total distributions and the fund’s earnings since inception to-date, the MRFP should discuss the rationale for continuing to make distributions, the impact of the distributions made by the fund on the fund’s ability fulfill its investment objectives, and how the shortfall will be made up going forward in the future.

Staff will continue to consider whether additional guidance or rule-making is needed in this area.