Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 415

Warning about timing of investments in ETFs and trusts

(This article republishes a previous warning at the end of the financial year about timing of distributions).

Most fund managers struggle to deliver a 1% outperformance after fees, and with the cash rate at 0.1%, 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 after a distribution 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 was 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. For example, these ETFs listed on the Australian exchanges fell heavily after their FY21 distributions.

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 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 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.

 

Graham Hand is Managing Editor of Firstlinks. This article is general information and does not consider the circumstances of any investor.

 

6 Comments
John Wilson
July 11, 2021

Although articles about investing in June highlight the problem, inherited previous unrealised capital gains can be a potential negative for new investors in unit trusts regardless of which month they might invest.

Geoff F
July 11, 2021

Good point John. Is there any reporting (daily basis) by funds which reveal their unrealised capital gains position so investors can determine how much CG they're buying ? I'm invested with one of the majors and I haven't seen any reporting along these lines.

Peter Thornhill
July 10, 2021

Working in the funds management industry I remember well a new fund that we launched and it coincided with the governments allowance of a tax deduction for gearing into overseas funds. there was a surge of interest prior to the tax year end and then in July the fund distributed a 20% dividend. It was repeated the following year which meant that 'investors' had 40% of their capital returned within 2 years and a commensurate fall in the unit price. Avoid the trap, use a listed company structure.

Danny
July 18, 2021

You referring to LIC's Peter?

CC
July 07, 2021

yes a very important reason why the supposed advantage of active ETFs over LICs is not what it's cracked up to be.

Davo
July 07, 2021

Hi graham, good and valuable article. My first ever investment was accepted on 30 June one year and I was stung badly....a lesson well learned. The Article howver would be much more valuable in May -June though, not a week too late for anyone to avoid the trap

 

Leave a Comment:


RELATED ARTICLES

Two of the best-kept secrets for the EOFY

Warning about investing in unit trusts in June

Warning about investing in unit trusts in June

banner

Most viewed in recent weeks

An important Foxtel announcement...

News Corp's plans to sell Foxtel are surprising in that streaming assets Kayo, Binge and Hubbl look likely to go with it. This and recent events in the US show the bind that legacy TV businesses find themselves in.

Warren Buffett changes his mind at age 93

This month, Buffett made waves by revealing he’d sold almost 50% of his shares in Apple in the second quarter. The sale not only shows that Buffett has changed his mind on the stock but remains at the peak of his powers.

Wealth transfer isn't just about 'saving it up and passing it on'

We’ve seen how the transfer of wealth can work well, with inherited wealth helping families grow and thrive for generations, as well as how things can go horribly wrong. Here are tips on how to get it right.

Welcome to Firstlinks Edition 575 with weekend update

A new study has found Australians far outlive people in other English-speaking countries. We live four years longer than the average American and two years more than the average Briton, and some of the reasons why may surprise you.

  • 29 August 2024

The challenges of building a portfolio from scratch

It surprises me how often individual investors and even seasoned financial professionals don’t know the basics of building an investment portfolio. Here is a guide to do just that, as well as the challenges involved.

Welcome to Firstlinks Edition 573 with weekend update

Steve Eisman, best known for his ‘Big Short’ bet against US subprime mortgages before the 2008 financial crisis, is now long and betting on what he thinks are the two biggest stories of our time: AI and infrastructure.

  • 15 August 2024

Latest Updates

Investing

Legendary investor: markets are less efficient and social media is the big culprit

Despite an explosion in data, investment titan, Cliff Asness, believes the market has become less efficient, not more, over his 34-year career. He explains why, and how you can take advantage of it.

Property

A housing market that I'd like to see

Our housing system isn't working, with prices and rents growing faster than wages, longer public housing waiting lists and more people are experiencing homelessness. Here are five ways to ease the crisis.

Retirement

It isn’t just the rich who will pay more for aged care

The Government has introduced the biggest changes to aged care in almost 30 years. While the message has been that “wealthy Australians will pay more for aged care”, it seems that most people will pay more, some a lot more.

SMSF strategies

Meg on SMSFs: At last, movement on legacy pensions

Draft regulations released this week finally provide the framework for unwinding legacy pensions cleanly and simply for members who choose to do so. There are some caveats though, including a time limit.

Investment strategies

A megatrend hiding in plain sight: defence

Global defence spending has inflected higher, bringing huge opportunity to a group of companies that have already outperformed broader market indices over the long-term.

Investment strategies

The butterfly effect, index funds, and the rise of mega caps

Index fund inflows to the US market are relatively tiny. Yet a new research paper suggests that they have distorted the size of the market's largest stocks to a surprising degree.

Investment strategies

Options for investors who don't want to sell overpriced banks

The run-up in Australian bank stocks has some investors confounded: do they continue to hold them in expectation of further gains - or sell and take profits now? There are alternative options to consider.

Sponsors

Alliances

© 2024 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. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. 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.