Avoid tax-time dinosaurs

The listed company would explain that the high dividend indicates a brighter outlook and the share price would get a boost. ETFs and other managed funds paying exorbitant dividends are not required to disclose why, although investors might get some hints from their annual tax statement, if they have the know-how to interpret those complicated documents.

The most common reason for high dividends paid by an ETF or other managed fund is that a lot of capital gains have been realised during the year and the fund has chosen to pass the cash equivalent of those capital gains to the investors. This will be reflected in the tax statement.

There are two negatives about high fund dividends. First, the investor probably doesn’t need all that cash for their living needs. They have become significantly disinvested and need to reinvest to secure their future returns. Second, the high dividend can be an indication of a high tax liability.

This choice of paying out a high amount because it reflects a high tax liability used to be a compulsory feature of ETFs and other managed funds. But the law changed several years ago, bringing in an ‘attribution’ system. Under this new system funds are able to choose appropriate amounts for their dividends rather than being tied to the randomness of a tax calculation.

It’s curious why these ETFs and other managed funds aren’t taking advantage of that change in the law.

It has been noted that several of the ETFs paying high dividends are funds that hedge their currency exposure. The taxation of currency hedges is a thorn in the side of those who let tax numbers determine their dividends. It is likely for those funds that the high amount comes not just from capital gains on their share portfolio but also from the profits on their currency hedges.

Again, this is a failure to take advantage of a change in the law. It has been a long time since the Government modernised the tax rules for hedging rules. The Government specifically did this so that funds can operate the way their investors want them to. The bizarre connection between the investors’ cash flow and the tax timing rules has been removed.

Despite the Government doing its part for both capital gains and hedging, most investors are yet to see any benefit. The new tax laws empower funds to pay a cash flow that meets their investors’ needs but so many funds have just continued the poor practices of the past.

In particular, fund managers have found the hedging fixes in the tax law to be too difficult. Most managers who should be using them, are avoiding them, even though those managers are being paid to provide expertise.

No-one’s breaking the law but fund managers are failing to use the new laws in the way that their investors need them to.

The good news is that some fund managers, like VanEck, have been more diligent. Some of us have put in a lot of effort to adapt our systems to approach things in a new way. But the degree of difficulty has been only one obstacle for those who have failed to step up. There is too much inertia; too much of the attitude that unless absolutely forced to make a change, they’ll just keep doing what they’ve always done.

Investors have a right to be disgruntled.

So be choosy – be sure to pick the right fund manager.

If you want stable income, you cannot just trust that you have chosen the right asset class. You also have to make sure that you choose the right fund manager as well as a fund that delivers the cash flow you need.

Therefore, it is important to ask the right questions.

‘AMIT’ stands for 'attributed managed investment trust', and removes restrictions on cash flow. Many fund managers have elected AMIT, but they are not using it.

So, the first question to ask a fund manager is whether they are using AMIT to smooth the flow of payments you will receive.

You may already know the answer.

While, AMIT can be used to smooth income payments the ‘ToFA hedging rules smooth the tax liabilities for investors in a hedged fund. Without it, hedging can lead to tax shocks.

While you are asking your fund manager about income, ask whether they are using ToFA to smooth the tax liabilities caused by hedging.

If you ask VanEck these questions, the answers for our ETFs will be an emphatic YES and YES.