Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 361

Warning about investing in unit trusts in June

Most fund managers struggle to deliver a 1% outperformance after fees every year, and with the cash rate at 0.25%, investors need to eke out every bit of return they can find. So it’s important to know how investment structures work. In particular, the tax impact of investing in June can be a trap for the unwary and cause unexpected leakage in tax.

Distributions from a unit trust

In a unit trust, all income received (including realised capital gains) is divided among unit holders based on how many units they hold at the time of a distribution. Unit holders must then include their share of this income (which may comprise dividends, interest, capital gains and franking (imputation) credits) in their own tax return in the year it was earned.

The same distributions are paid to all unit holders according to their holding on a particular day, whether or not the investor has been in the fund one day or one year. Distributions are not pro-rated for investors who were not unitholders for the whole period. An investor may receive some of their investment back immediately as income if they invested just before a distribution.

Immediately after a distribution is declared, the unit price of the fund will usually fall by the amount of the distribution, because the distribution reduces the fund’s assets.

Don't convert capital to taxable income

An investment in June that receives a distribution in July may be converting capital to taxable income. For example, if someone invests on 25 June 2020 when the unit price is say $1.00 and then a 10 cent per unit distribution is made on 30 June, the unit price will fall to 90 cents (assuming no market movement) at the beginning of July. The 10 cents will be taxable income in the hands of the unit holder in their 2019/2020 tax return.

Obviously, the worst consequences are for individuals with high marginal tax rates where the distribution includes no franking credits. This might be the case for a global equity fund which distributes once a year with no franking credits from Australian companies.

Alternatively, an investor such as a tax-free charity or super fund in pension mode in an Australian equity fund might pay no tax and receive a franking credit, so a June investment might actually be favourable for them.

The only way to eliminate these effects would be for the fund trustee to make a daily distribution, but clearly this is not practical. The more often a fund distributes income during the year then the less of an issue this distribution inequity becomes. For example, most Australian equity funds distribute twice per year but most international funds only distribute once per year.

Other funds with particularly punitive outcomes for unit holders who invest close to a distribution date might be actively-traded funds in a rising market. They might have large capital gains on shares not held for longer than 12 months (and therefore, not subject to the 50% CGT discount factor). The distribution might contain a large taxable capital gain component.

How do we handle the problem with the Third Link Growth Fund?

Many of you know I manage a unit trust, the Third Link Growth Fund. I consider this issue of such significance that from the start of May each year, I ask our administrator to contact every new applicant and check whether they understand the tax consequences. While this might cost us some application money in the short term, hopefully it builds a better long-term investor experience.

I also provide a health warning in the PDS for Third Link Growth Fund. It says: "Distributions are not pro-rated for investors who were not unitholders for the whole period, meaning that you may receive some of your investment back immediately as income if you invest just before a distribution."

Anyone who invests in a unit trust in June should at least ask the fund manager for an estimate of the distribution and its tax components, unless they want to share the tax burden for prior investors.

 

Chris Cuffe is Founder and Portfolio Manager of the charitable trust, Third Link Growth Fund and and Chairman of Australian Philanthropic Services. The views expressed are his own.

 

RELATED ARTICLES

Warning about investing in unit trusts in June

banner

Most viewed in recent weeks

After 30 years of investing, I prefer to skip this party

Eventually, prices become so extreme they bear no relationship to reality, and a bubble forms. I believe we are there today, not for all stocks but for many in the technology space.

Australian house prices: Part 2, the bigger picture

There is good reason to believe the negatives will continue to outweigh the positives over the next 12 to 18 months. There is more concern about house prices than the short-term indicators suggest.

How to handle the riskiest company results in history

It is better to miss a results bounce and buy after the company has delivered than it is to step on a landmine. With such uncertainty, avoid FOMO by following these result season investing tips.

Australian house prices: Part 1, how worried should we be?

Three key indicators are useful for predicting the short-term outlook for house prices, although tighter lockdowns make the outlook gloomier. There is enough doubt to create cause for concern.

Welcome to Firstlinks Edition 369

Imagine you had perfect foresight about COVID-19 at the start of the year. You correctly foresaw that the global pandemic would kill over 700,000 among 20 million infections by August. In Australia, borders would close, cities would be locked down, most mortgagors would be on income support and companies would be allowed to trade while insolvent. You then had to guess how much the stock market would fall. Would you say about 10%?

  • 6 August 2020

The rise of Afterpay and emergence of a new business model

Sometimes the simplest ideas are the best. The founders of Afterpay stumbled on the attraction for consumers of paying by instalments, and now retailers must offer the facility or lose business.

Latest Updates

Shares

The 'Heady Hundred' case for unglamorous growth

Checking global stocks with higher prices than the FANGAM stocks but weaker margins and growth identified almost 100 companies. Astonishingly, the ‘Heady Hundred’ are valued at over US$3 trillion.

Shares

Share Purchase Plans brickbats and bouquets

Many Share Purchase Plans leave large gains on the table for institutions, but some companies are handling them more equitably. As a shareholder, check if your company receives a pass or a fail.

Shares

Three things we have learnt about listed companies in 2020

Many companies have strengthened their balance sheets but their soundness can be directly correlated to the duration of the pandemic. What lessons has 2020 revealed coming into reporting season?

Investment strategies

What does the 'fear gauge' VIX really mean?

The VIX as a measure of risk has a place in equity markets in interpreting market sentiment, but it is overly simplistic to think it can represent volatility in equities as a whole. Just what is it?

Shares

Where we see growth opportunities in software stocks

Financial software companies have favourable attributes and industry tailwinds that may see investors rewarded, especially with super funds driving for greater efficiencies and better member experiences.

Retirement

Five ways to use the family home for retirement income

The family home is the bedrock on which many retirement plans sit, with special tax and social security benefits. Many products generate an income stream from the home to make retirement more comfortable.

Sponsors

Alliances

© 2020 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use.
Any general advice or class service prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, has been prepared by without reference to your objectives, financial situation or needs. Refer to our Financial Services Guide (FSG) for more information. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.