Morningstar - Q2 2021 - 24

Dispatches

natural income generation-that is, the income
that a fund receives from coupons and dividends.
We found that the costs of high distributions
may be considerable, including depletion
of assets, a declining trend in the distribution
amount, and lower total returns.

We assessed funds from October 2015 through
September 2020, breaking down the price return
on investment-which equals the return
an investor receives excluding distributions and
is reflected in the change of net asset value-
and distributions.

The Income Analysis view in Morningstar
Direct allows us to identify the types of
funds that are more likely to be paying overly high
distributions compared with the incomegenerating capacity of their underlying assets.

Our analysis showed that distribution frequency
is a key factor. Annual payments are the
most common, with 44% of funds making annual
distributions. But 30% of all funds-and
the majority of fixed-income funds-distribute

monthly. Most of the rest distribute semiannually
or quarterly. (Only 1% of funds distribute
bimonthly, so results there should be taken with
some caution.)
Funds that distribute payouts monthly appeal
to income-seeking investors. On average,
monthly distributing funds have a much higher
yield than lower-frequency funds: They
average a 6% five-year annualized yield compared
with less than 1% for funds that distribute
annually. But monthly payouts tend to greatly
exceed the underlying funds' organic
income generation, leading to a faster depletion
of assets.

Funds With Monthly Distributions Average Lower Total Returns
Price Return

Distributions
6,483
16,406

13,390
95,583

35,486

111,711

2,461

JPY 150,000

120,526
100,000

97,505

73,660
50,000
0

Monthly
Distribution Period

Bimonthly

Quarterly

Semiannually

Annually

Source: Morningstar Direct. Data from 10/01/2015 -09/30/2020.

Funds With Monthly Distributions Average Lower Payouts Over Time
Year 1

Year 2

Year 3

Year 4

Year 5
JPY 10,000
7,500
5,000
2,500
0

Monthly
Distribution Period

Bimonthly

Quarterly

Source: Morningstar Direct. Data from 10/01/2015 -09/30/2020.

24

Morningstar Q2 2021

Semiannually

A chart showing a breakdown of average fund
returns grouped by different distribution
frequencies is revealing. The data set assumes
an invested amount of JPY 100,000. If the
sum of total distributions received and price return
on investment is below JPY 100,000, it means
that the investor's wealth has diminished.
In this case, over the five-year period analyzed,
the average investor's wealth increased
regardless of distribution frequency. However,
the total returns differ considerably by
distribution frequency, with less frequent payers
earning higher total returns on average.

Annually

We found even more pronounced differences
when looking only at equity funds. Annually
distributing funds have created a much
higher total return than monthly distributing funds,
as assets have been allowed to stay invested.
For the average monthly distributing equity
fund, only about three fourths of original capital
remained after the five-year period. This
means that monthly paying funds have shrunk
through time, and if they maintain payout
levels of more than 6% annualized, it is fair to
expect them to continue to shrink, unless natural
sources of income improve considerably.
Although this " reversal of principal " phenomenon
is explained in fund prospectuses in Japan,
it is not an ideal practice from the standpoint
of an investor whose objective is to grow
assets over the long term. That's why when the
tax-benefit plan Tsumitate NISA was
introduced in January 2018 for Japanese investors
Morningstar - Q2 2021

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