Matias Möttölä, Morningstar
The prolonged low-rate environment has led investors in Asia to seek income-generating funds that often boast high distributions.
“However, these funds come with risks that may not be evident to all investors,” said Matias Möttölä, Morningstar’s associate director, multi-asset and alternatives. “To produce the types of pay outs craved by investors of at least 4% annually, portfolio managers may need to take plenty of risk that the typical fund investor is likely not aware of.”
A recently published Morningstar study on income funds selling in Asia (Hong Kong, Singapore and Taiwan) found that funds with higher payouts have seen their unit price slightly shrink, on average, over the trailing five-year period, as they have reached into their capital to pay distributions in a period of low market yields.
Moreover, monthly distributing funds have paid out a far larger part of their assets to investors than funds distributing semi-annually or annually. Average annualised distribution yields for monthly-payers were 4.2% in Hong Kong, 4.5% in Singapore, and 4.4% in Taiwan.
However, as a result, the average monthly distributing fund has seen its capital eroded, which in turn has led to a lower distribution level year by year.
“This is hardly an ideal situation for fund investors seeking a stable income to supplement their retirement or other regular income,” said Möttölä.
Within the Hong Kong fund universe of bond funds paying out more than 4% annualised yields, 49 out of 65 (75%) sunk below their starting capital, as they had not earned enough natural income from markets to afford their distributions without touching their capital. Among allocation or balanced funds (13%) and equity funds (25%), the proportion ending up with a lower NAV than at the start of the period was healthier.
There are 185, 172 and 156 income funds available for sale in Hong Kong, Singapore and Taiwan respectively, with a minimum size of $100m as of the end of April 2021, according to Morningstar. Most of them are fixed income products.
Yet, the yields on fixed-income securities cannot sustain a high level of fund distributions for an extended period without eroding capital – which inevitably means declining payout rates in future years.
But, lower distribution fixed income funds registered lower total returns compared with the highest-yielding group. “The likely reason for this is that the higher-payout funds tended to venture into riskier
