Income fund yields down

Last year was a good one for income investors – but not as good as 2003 was. That’s the bottom line of the annual survey of dividend funds, income trusts funds, and income-oriented balanced funds recently published by the Mutual Funds Update newsletter. It covered the 2004 calendar year.

Out of 14 income trusts funds and balanced funds that showed a year-over-year change in cash flow yields, 10 came in below their 2003 level (67 per cent) while only five showed a gain. Dividend funds fared slightly better with nine of 15 (60 per cent) registering a decline.

These results are significant for income-oriented investors because a drop in cash flow can result in financial problems if investment income is a large part of household revenue. TD Monthly Income Fund, for example, decreased its payout by 19 per cent in 2004 over the previous year. Talvest Dividend Fund showed an even larger decline, reducing its distribution by 31 per cent. For anyone relying on income from these funds, that hurts.

Where to look for cash
As was the case in previous surveys, income trusts funds and balanced funds were the better choice whent came to steady cash flow. The average cash flow return of all the funds in this group that were covered by our survey was 6.7 per cent. The dividend funds we looked at, by contrast, showed an average cash flow return of only 2.9 per cent. If a high cash yield is important that tells you where to look for it in the mutual funds world.

The top funds in their categories in terms of cash flow were Clarington Canadian Dividend Fund at 11.2 per cent and Clarington Canadian Income Fund at 9.1 per cent. However, there is an important caveat here. Both funds showed a higher cash flow return than their total return. That means the managers were effectively giving investors their own money back to make up the difference. I don’t regard that as a healthy situation if it continues for any length of time. All the other funds in the survey had a higher total return than their cash flow return.

(Cash flow return is calculated by dividing the fund’s total payouts for the year by the net asset value on Jan. 1, 2004. Total return takes into account all profits in the portfolio including unrealized capital gains.)

The best ratio among the income trusts/balanced group was Acuity Income Trust Fund which produced a cash flow return of 8 per cent on distributions of $1.02 a unit. The fund’s total return for 2004 was 38.5 per cent, the highest we found in our survey.

Among dividend funds, the best combination was achieved by the Mackenzie Sentinel Income Fund with a 4.9 per cent cash flow return and a 9.6 per cent total return. Several other dividend funds had higher total returns but very little cash flow such as TD Dividend Growth Fund which gained 16.8 per cent overall but paid out only 1 per cent in distributions.

General guidelines to follow
Based on the results from this and previous surveys, here are some general guidelines for income-oriented fund investors.

Be careful with dividend funds. Most dividend funds now invest primarily in blue-chip stocks and their distributions may be minimal as a result. For example, the Phillips, Hager & North Dividend Income Fund has a great history and returned 14.5 per cent in 2004. But it is not a fund to buy if you need income; the 2004 cash flow return was a microscopic 0.9 per cent.

Watch out for misnamed funds. The Mavrix Dividend and Income Fund is officially classified as a dividend fund but you’ll find a lot of income trusts in the portfolio which skew the results and make this much more of a balanced fund.

Hold tax-efficient funds in non-registered plans. The newsletter’s tax-efficiency table for 2004 shows seven funds that paid out 60 per cent or more of their distributions in tax-deferred return of capital. You lose the benefit of this tax break if you keep the funds in an RRSP or RRIF.

Check the distribution pattern. Most of the income trusts funds and balanced funds in the survey pay regular monthly distributions. The payments from the dividend funds can vary from monthly to annually. If steady cash flow is important, be sure the fund you select makes payments at least quarterly.