What you should know about income-payout funds

[SINGAPORE] An interview in October with Pimco chief investment officer Dan Ivascyn made me sit up.

Market yields are now the most attractive they have been over the past two decades, he said. It is an opportunity for long-term investors like retirees to lock in a relatively high current income.

The clincher was the strong historical correlation between the starting yield of fixed-income assets and the return that accrues to investors over three to five years. The correlation, based on data supplied by Pimco, is 95 per cent.

As at September, the current yield of the Bloomberg US aggregate bond index was 5.6, compared with the average yield since 2010 of 2.9 per cent, data compiled by Pimco shows.

That got me thinking. Would Singapore investors eventually reap today’s portfolio yield?

In reality, some factors get in the way – not least of which is whether an investor spends the income when he or she receives the payout. Similar factors apply to other asset classes such as equity income and multi-asset income funds which distribute an income.

Here are some things to consider.

Total-return investing

If you peruse funds’ fact sheets, returns are typically presented in two formats, net of fees. One is based on net asset values (NAVs), or bid-to-bid pricing; the second accounts for a sales charge, assumed to be 5 per cent.

It is likely that hardly anyone pays 5 per cent, however. There is no sales charge if you invest via digital platforms such as Endowus.

Total return is calculated based on capital appreciation plus reinvested dividends or income. This is how returns are reflected in funds’ fact sheets.

But in a distribution share class, if you receive the income and spend it, your effective total return will be substantially lower.

As an example, Pimco Income Fund’s strategy, which is US dollar-denominated, had a portfolio yield to maturity of 8.37 per cent at end-September 2026. In the three years to Sep 30, it generated an annualised total return, net of fees, of 5.87 per cent.

The portfolio itself has an effective duration of 7.36 years and an effective yield to maturity of 8.37 per cent. The annualised distribution yield is 6.49 per cent.

So far, so good – as long as your units are reinvested, and you invest in US dollars.

In comparison, the three-year annualised returns from the Singapore dollar-hedged share class, which is invested in exactly the same portfolio, is a markedly lower 3.55 per cent – a differential of around 2.3 percentage points.

This takes us to the next point.

Cost of currency hedging

Many funds are denominated in US dollars, but they do offer a Singapore-dollar hedged share class, which makes sense if you live in the city-state. But a strengthening of the Singdollar against the greenback could substantially dilute your returns upon conversion.

Hedging is supposed to cushion the impact of forex fluctuations. But it is not perfect and could add to the cost.

Here is how currency hedging works. A fund manager enters into a forward contract to convert an agreed amount from the fund’s base currency to the hedged currency at some future date, maybe a month.

Pimco offers a clear explanation. The main driver of the hedging outcome, it said, is the interest rate differential between the US dollar and Singdollar.

When Singdollar rates are below US dollar rates, hedging the US dollar exposure back to Singdollars creates a negative carry which could affect returns.

The opposite, of course, could happen as well, where a positive carry could add to returns. “Our latest internal estimate, based on three-month implied forward yields as at Oct 23, puts the annualised US dollar-to-Singdollar hedging impact at around 2.45 per cent,” Pimco said.

The estimate of 2.45 per cent, it added, is “a simplified point-in-time proxy based on rolling three-month FX forwards”. The actual realised hedging cost can also be affected by changes in rate differentials over time, hedge timing and rebalancing, among others.

The three-year annualised return also captures the realised cost of hedging over the entire historical period. It included the US Federal Reserve’s rapid tightening, which materially widened the USD-SGD rate differential.

“Our earlier work on the Singdollar share class similarly identified the widening USD-SGD rate differential as the main reason hedging costs had risen.”

Fund payouts: from portfolio income or capital?

Most fund prospectuses allow managers to distribute income out of the fund’s capital, as well as from capital gains and/or portfolio income. Payment out of capital is essentially a return of your capital, and not an investment return.

There are a variety of reasons managers may draw from capital for fund distributions. One is if the fund has marketed a “fixed” yield and the yield from the underlying assets is insufficient. Another is the desire to maintain a stable distribution.

Based on Pimco’s disclosures, the share of the Income Fund’s distribution out of capital ranged between 17 and over 50 per cent in 2026 for the US dollar distribution share class.

For the Singdollar-hedged distribution share class, the share of payouts from capital appears broadly comparable at between 18 and 59 per cent.

Payouts out of capital are not unique to Pimco. Thanks to Singaporeans’ voracious appetite for income, funds may be marketed on the strength of a regular payout, which can be monthly. Note that there is a mismatch between a monthly payout and the income from underlying assets, which is earned six-monthly or annually.

The “accumulation” share class is available for those who wish to reinvest the dividends.

This is worth noting on Pimco’s website: “A positive distribution yield does not imply a positive return.” Dividends paid out of capital may result in “an immediate reduction of the fund’s NAV per share”.

Another example is Schroder’s ISF Multi Asset Growth & Income Fund, which invests in global fixed income, convertible bonds and global equities.

The fund is marketed with a historical distribution rate of 6 per cent. As at September, 87 per cent of the income distribution came from capital.

Dorian Carrell, Schroders’ head of multi-asset income, said monthly payouts provide a “smooth and predictable distribution profile, while the underlying coupons and dividends are received more unevenly, often semi-annually or annually”.

“As a result, the proportion classified as capital may be higher in certain months but should be considered in the context of income generation over a longer period. In August, 100 per cent of the distribution came from income.”

Some investors, he added, may prefer a high distribution “with the understanding that part of these distributions may be funded from capital, which may reduce the NAV of the relevant share class and the capital available for future investment”.

The fund’s underlying income, he said, has been “consistently 5 per cent or above”.

“Given its total return approach and performance over recent years, we believe the approximately 1 per cent gap between the underlying yield and distribution target may be funded from capital growth over time, although this is not guaranteed,” Carrell added.

“It is also worth noting that our definition of income from fixed-income securities is yield to worst, which incorporates securities trading below par that gain in value as they approach maturity.”