Don’t judge fund by name

In the world of investing, things are not always as they seem. People may get on the wrong track because of bad advice, incomplete information, unexpected risk factors and unrealistic expectations. The issue that most infuriates me, however, is one that should not even exist: misleading names. Let me give you a classic example.

There is a mutual fund category that is now officially designated as “Canadian Dividend.” However, the funds in this group are still commonly known as “dividend income funds,” which was the official name for many years.

In my experience, the dividend fund issue is the single biggest source of investor confusion. It needs to be addressed by the industry on a priority basis.

The Canadian Investment Funds Standards Committee states the objective of these funds “is to provide a tax-advantaged regular stream of income” through the use of dividend tax credit.

Higher yields attract
Dividend funds have attracted a lot of attention in recent years because of the low interest rate climate that prevailed following the stock market plunge that began in early 2000. With traditional safe haven securities such as GICs and vernment bonds offering microscopic yields, income-seeking investors sought alternatives. Dividends were an obvious choice; in some cases, dividend-paying stocks were offering higher yields than GICs and had, as a bonus, built-in tax advantages.

For those who prefer mutual funds to investing directly in the stock market, dividend funds seemed to provide the answer. Billions of dollars poured into them. The Investment Funds Institute of Canada does not track the Canadian Dividend category as such but it does have a “Dividend and Income” category. In January 2000, a little less than $18 billion was invested there. At the end of October 2004, the figure stood at almost $49 billion, an increase of 172 per cent.

Did all these people get what they were expecting? I doubt it.

Next page: Why it wasn’t what people thought

Most dividend income funds provide minimal cash flow. In fact, they are more like blue-chip stock funds, where the lion’s share of the returns comes from capital gains, not dividends.

The highly successful Phillips, Hager & North Dividend Income Fund falls into this group. Over the years, investors have done well with this fund; the average annual compound rate of return for the decade to Oct. 31, 2004, was more than 17 per cent. But almost all of that came from capital gains. Over the year to the end of September 2004, the fund paid out $0.41 per unit. In terms of yield, that worked out to 0.7 per cent. Who said GICs were stingy?

Of course, few people complained because the managers were doing so well in the markets. But if you invested on the assumption you were going to receive an above-average income stream, you may wonder what went wrong.

This is not an isolated case. Most funds in the Canadian Dividend category demonstrate the same characteristics. Only a few provide the kind of dividend income many people are looking for.

Check the statements
To identify them, you must get a copy of the most recent financial statements and look closely at the portfolio. A fund that owns a high percentage of preferred shares will generate the cash flow you’re seeking. But in most cases, you’ll find few, if any, preferreds in the mix.

The preferred share market is small, and few companies are issuing new ones. As a result, money managers are finding it increasingly difficult to buy good-quality preferreds for their funds. The shortage forced the GGOF Monthly Dividend Fund to hang out a “closed” sign for new investors in March 2004.

One of the few remaining true dividend income funds is the Signature Dividend Fund, which is operated by CI Fund Management. At the time of writing, 43 per cent of the portfolio was invested in preferred shares, and this has been fairly consistent over the years. The fund makes monthly distributions of $0.04 a unit for a yield of four per cent over the year to Oct. 31, 2004. Ask an adviser if it is suitable for your needs.

The sad fact is the true dividend income fund is almost extinct. The category should no longer officially exist, even under the Canadian Dividend name. Most of the funds in this group should really be in the Canadian Equity category. The existing situation only serves to confuse and mislead investors.