Mutual funds that offer managed payouts designed to give investors a steady stream of income have caught the attention of Andrew J. "Buddy" Donohue, director of the division of investment management at the Securities and Exchange Commission.
Such funds are likely to become more popular as it becomes harder for investors to find income in the current low-interest-rate environment, he said last week in Phoenix at a conference sponsored by the Washington-based Investment Company Institute.
As that happens, fund sponsors need to be careful in marketing such funds, Mr. Donohue said. Sponsors need to make sure that they inform investors that payments made by the funds come from principal, not earned income, he said.
If they don't, sponsors could find themselves in trouble with the SEC, Mr. Donohue added.
It was a timely warning.
Three managed-payout funds from
Charles Schwab Investment Management Inc., a unit of The
Charles Schwab Corp. of San Francisco, are expected to begin operations this week.
Other such funds from John Hancock Financial Services Inc. of Boston and
The Vanguard Group Inc. of Malvern, Pa., are expected to hit the market any day.
They would join managed-payout funds launched last month by DWS Scudder, the U.S. retail division of the asset management subsidiary of Deutsche Bank AG of Frankfurt, Germany; and those launched in October by
Fidelity Investments of Boston, which was first to market.
For its part, Fidelity makes it very clear that its managed-payout funds are designed to return principal, Stephen D. Fisher, the firm's senior vice president and deputy general counsel, said at the conference. In fact, the funds liquidate when they reach a set date, he said.
That approach differs from that most other fund providers appear to be taking.
Funds expected from DWS Scudder, John Hancock, Schwab and Vanguard seek to preserve capital while making distribution payments.
Such funds, however, may be trying to promise investors a little too much, Mr. Fisher said.
Some of the payout funds seeking to preserve capital are targeting "awfully high," he said.
COMES WITH A WARRANTY
One of the largest payouts comes from the DWS LifeCompass Income Fund (INCAX). It seeks to make a fixed-dollar distribution equal to an 8.25% annual yield, based on the fund's initial share price of $10. Distributions are made twice a year, and the fund is structured to target its objectives over a 10-year horizon.
Of course, that fund is unusual in that it comes with a warranty.
The fund's ability to provide regular distributions is protected by a third-party financial warranty with Merrill Lynch Bank USA of New York, which helps ensure shareholders receive periodic distributions as well as the return of at least a portion of their principal — with no less than 17% returned at maturity.
More typical are the proposed Vanguard funds. Depending on the fund, investors can expect a 3%, 5% or 7% annual distribution, according to the funds' prospectuses.
"We think the investment objectives we have set are reasonable," said Amy Chain, a spokeswoman for Vanguard. And just in case Vanguard can't meet those objectives, "we have made it clear there is no guarantee," she said.
It is too early to tell whether that approach, or the one favored by Fidelity, will win over investors looking for income, said conference attendee Thomas F. "Tif" Joyce, president of Joyce Financial Management of Sebastopol, Calif.
He compared the current and proposed managed-payout funds to the debate that once raged over which video cassette player-recorder would be dominant: Betamax or VHS.
"I think we're on to something," Mr. Joyce said about the competing managed-payout funds. But he will take a wait-and-see approach until it is clear how the funds actually perform.
Vanguard said it doesn't think that managed-payout funds that seek to preserve principal, and those that intentionally pay back principal, are mutually exclusive.
Each strategy can be attractive to different investors, Ms. Chain said.
E-mail David Hoffman at [email protected].
