Use caution when tracking unit values of mutual funds

Do you track the unit values of your mutual funds? Generally, when investors track unit values, they are trying to follow the price of a fund to give them an idea how well or poorly that fund has done.

For those that do track price, at certain times of the year strange things seem to happen. For example, markets are going up but all of a sudden, the unit value of a particular mutual fund goes down. Let’s say you’ve tracked a mutual fund for a long time and it seems to be going nowhere because the value has stayed relatively the same all the time. Commonly at the end of the year, end of the month or end of a quarter, a lot of mutual funds may face drops in unit price but you may be surprised to know that the drop has nothing to do with poor market performance.

Why does this happen? It all has to do with mutual fund distributions. Managers of mutual funds buy and sell individual stocks, bonds and other investments within their funds because that is what they are supposed to do. But every time they trade, it can trigger investment income like capital gains. In addition, mutual funds accumulate dividends from the companies they hold as well as interest income from fixed income investments. In most mutual funds, this income is taxable and must be flowed through to unit holders through tax slips like T3’s and T5’s generated by the mutual fund companies.

If you hold a mutual fund where distributions are paid out to you in income, you typically take these distributions into account when you are measuring how well your fund has done.

If you hold a mutual fund where distributions are reinvested, tracking the price alone will likely disappoint you. Every time there is a distribution, your distribution buys more shares. But to keep everything correct, unit values have to be adjusted downward accordingly. The dollar value of your holdings, however, will remain constant. Let’s look at a couple of examples:

Guardian Monthly High Income Fund.

A great example where tracking unit values does not work is with monthly income funds. In these cases, monthly income funds pay a monthly distribution at the end of every month. If we look at the GGOF Monthly High Income Fund, this fund is designed to pay out 6 cents per unit per month. If you track the unit value alone, you will see that over the past year the unit value has increased only 6.2%. However, if you calculate the actual investor return and add in the dividends, the investor actually made 22.9%. The difference is the return that came from distributions.

In addition, in the last three months of the year, the distribution was increased from 6 cents to 26 cents in October, 31 cents in November and a whopping 76.4 cents in December. These extra distributions occur because the fund made too much in profits in 2005 and the fund must pass the tax onto the investors in the form of distributions.

CI Signature Select Canadian

If you look at the returns of this fund in 2005, you will see that it posted a 22.9% return. At the beginning of the year, the unit value was $16.57 per share. At the end of the year, the unit value was $18.89 per share. When you do the math, the fund increased in price by $2.41 or a 14.5% increase. Although this is impressive, there is a significant difference between the 22.9% return and the 14.5% return by tracking price. The difference is simply two distributions that the fund paid out in July and December.

The bottom line

Tracking unit values will almost always understate the performance of the fund because of distributions. The more frequent the distributions and the larger the distributions, the more discrepancy there can be in performance.

I advise that investors stop tracking unit values altogether because it is not how fund performance is calculated in the first place. Instead, track dollar values from your statements. It will be a much better measure of performance.

Leave a reply

Your email address will not be published. Required fields are marked*