In theory, the only thing that investors care about when comparing investments are the relative risk-adjusted rewards, but you don’t have to spend much time watching the market to know that people value all kinds of things that they shouldn’t. Dividends, for example, aren’t necessarily a good thing (better than sitting on cash, worse than productive re-investment), but it’s still something that many investors use as an absolute measure of quality.
“Some mutual funds purchase stocks before dividend payments to artificially increase their dividends, which we call ‘juicing’,” write Lawrence Harris and David Solomon of the University of Southern California Marshall School of Business and Samuel Hartzmark of the University of Chicago Booth School of Business in their paper Juicing the Dividend Yield: Mutual Funds and the Demand for Dividends. “Juicing is associated with larger inflows, and is more common among funds with unsophisticated investors.”
Measuring the excess dividend ratio
If a mutual fund wants to distribute cash to investors, all it has to do is sell some of its stocks and pay back capital, but it’s not allowed to denote the payment as a ‘dividend’ unless it is acting as a pass-through for dividends paid by securities that it owns. The labeling shouldn’t matter, but funds like the Huntington Dividend Capture Fund and the First Trust Dividend and Income Fund (with a ratio of income to assets of 19.31% in 2009) give some indication that the practice has popular appeal.
Electron Capital Partners' flagship Electron Global Fund returned 5.1% in the first quarter of 2021, outperforming its benchmark, the MSCI World Utilities Index by 5.2%. Q1 2021 hedge fund letters, conferences and more According to a copy of the fund's first-quarter letter to investors, the average net exposure during the quarter was 43.0%. At the Read More
To identify juicers, the researchers compared the ‘implied dividends’ that a fund should receive based on quarterly filings with the actual dividends that it received over the course of a year, defining the ratio of actual to implied dividends as the excess dividend ratio. You wouldn’t expect the two to be exactly the same quarter-by-quarter since filings only give a snapshot of fund holdings, but over a long period of time the differences should net out.
Instead, they found that some funds consistently juice their dividend yields, and that they are rewarded by retail investors for doing so (these funds typically don’t have institutional clients). Those with a an excess dividend ratio of 1.38 received an extra 6.8% in annual inflows compared to similar funds that don’t juice, and those with a ratio of more than 2 received 12.2% higher annual inflows.
Juicers also charge higher fees than their competitors
The harm is that paying out these high dividend yields is often a tax liability for investors, and the transaction costs incurred while jumping from position to position ahead of their respective dividend dates is definitely going to cost investors money. The First Trust Dividend and Income Fund, for instance, had an annual turnover rate above 2,000% when it achieved its incredible 2009 dividend yield.
“Juicing also is more common for funds with higher expenses, consistent with these funds catering to less sophisticated investors or marketing themselves on dimensions other than returns (which expenses will reduce),” write Harris, Solomon, and Hartzmark.
So not only are investors putting this artificial measure ahead of returns, racking up transaction fees, and increasing their clients’ tax bills, they charge more than competitors for the service.
See full study here.
H/T Jason Zweig