The Seven Sins of High-Yield Investing

Sin #4: Buying Into Managed Distributions

Some closed-end funds pay out what is known as “managed distributions” as a template for their dividend policy.

What happens
here is that the fund, in its attempt to draw investor attention, states that it will pay out a managed distribution that is a
percentage of the NAV at the end of each quarter. The idea being stability of income.

Hardly! Most closed-end funds that employ
a managed distribution payout policy use 8% as the percentage of NAV they peg the fund to at the end of the quarter.

So let’s say a healthcare fund trading at $10 that depends on paying its 8% stated yield from capital gains, interest and covered
call writing doesn’t earn enough to cover the 2% quarterly dividend payment. Let’s say they only earned about 1% of the 2% needed
to pay out to shareholders but by proxy have to pay out the full 2%. At this point, the fund manager has no choice but to pay
back the other 1% as a return of capital, again hoping to make up for the income shortfall in the quarters ahead. In this case,
we almost always will see shares of such a fund fall once it becomes known that the makeup of that managed distribution is not
fully earned.

The result of this is that when the price of the fund shares declines, so does the managed distribution of the 8% payout because
it’s a function of the price of the NAV and not a fixed dividend like most income funds.

NEXT: Sin #5: Owning Securities with High Payout Ratios