Income/Accumulation confusion

gingerscot

Hi All,

I have a fidelity ISA account invested in a variety of funds.

A few months back stuck £800 in Aberdeen European High Yield Bond I Acc and as it had a ~6% yield and monthly dividends. I thought what I'd see was approx ~0.5% = £4 per month being reinvested in new units in the bond. Clearly I'm wrong though as the transactions show;


Date, Type, units, price, amount
18/01/2016 Reinvested Tax : ReInvested Units 0.64 123.46 0.79 GBP
17/12/2015 Reinvested Tax : ReInvested Units 0.77 124.90 0.96 GBP
06/11/2015 Reinvested Tax : ReInvested Units 0.64 125.37 0.80 GBP
19/10/2015 Reinvested Tax : ReInvested Units 0.22 123.99 0.27 GBP
20/07/2015 New Investment 641.39 124.73 800.00 GBP

Total Valuation:
791.51 GBP(643.66 units @122.97)

I only seem to be reinvesting the tax? As £1/£800 * 12 is just over 1%. Plus that didn't even start appearing for a few months. For the fidelity money builder income fund that I used to hold the transactions showed as

24/07/2015 Dividend : ReInvested Units 1.45 118.60 1.72 GBP
26/06/2015 Dividend : ReInvested Units 2.28 117.60 2.68 GBP

The reinvested units were exactly the amount expected for the 3% income return, So even though this is an income fund, the money is being re-invested into new units. I'm not sure if I stated for the income fund to re-invest which may be causing confusion in my head as I opened that fund a few years back.

So my question is where is my bond "income" going? The valuation states the total units I own is exactly the sum of the transactions which clearly doesn't add up to a 6% yield?

The definition everywhere is
"With accumulation units income is retained within the fund, although the number of units remains the same the price of each unit increases and hence the value of your holding rises."

but I don't see that from the valuation (above in blue?)? What am I not understanding! The valuation is based on a unit price of 122.97 on my account yet on the fidelity site the Buy/Sell Price is 122.68. Is that something to do with it or is that just the valuation being a day out?

Thanks, Dave

dunstonh

So even though this is an income fund

Its not an income fund. Its an accumulation fund investing in income yielding investments.

So my question is where is my bond "income" going?

it is staying within the fund and reflected in the unit price (which goes up to compensate)

but I don't see that from the valuation (above in blue?)? What am I not understanding!

Whilst the unit price will increase because of income paid within the fund, it will also have other influences put on the unit price. Mainly the value of the underlying investments within the fund.

In this case, the fund is a higher risk bond fund and will be more volatile and the unit price has fallen in recent months.

If you wanted income then you needed to buy income units. Not accumulation. However, the actual return between both versions will be virtually identical in most cases.

bowlhead99

gingerscot wrote: »

Hi All,

I have a fidelity ISA account invested in a variety of funds.

A few months back stuck £800 in Aberdeen European High Yield Bond I Acc and as it had a ~6% yield and monthly dividends. I thought what I'd see was approx ~0.5% = £4 per month being reinvested in new units in the bond. Clearly I'm wrong though

Yes, you have selected an 'accumulation' fund, which is why the name of the product has 'Acc' on the end.

The fund invests into bonds that pay interest with a high yield (but are risky so the capital value can go up and down). The income that is made by the fund turns up as cash in the fund's bank account. As this is an 'accumulation' fund, the fund prefers not to physically send the interest which it generates out to its investors, but instead, reinvest it in more interest-paying bonds.

So, the yield might be 6% but that yield is not going to be given to you to buy more units. You chose not to take income, but to let it accumulate. So as far as they are allowed, they will just reinvest it. So when you originally bought £800 of units which had a price of 124.73p each, you got 641 units and those units will hopefully get more valuable over time, because the income that the fund makes (less the running costs of the fund like management fees and other operating expenses) will be reinvested and buy more and more new investments.

The definition you found of what an "accumulation" fund does, is correct:

The definition everywhere is
"With accumulation units income is retained within the fund, although the number of units remains the same the price of each unit increases and hence the value of your holding rises."

At least, that is the BASIC case of what an accumulation fund does. You will NOT get the 6% paid to you in cash. As I mentioned above, so far as they're allowed, they will retain it, and buy a bigger pile of investments with it.

But there is a slight difference with this type of fund and the way you hold it. Funds like this which earn a lot of interest income generally pay the proceeds out to investors as interest, and the government tells them they must withhold 20% for tax from those interest distributions and pay it over to HMRC on behalf of the investors.

You chose to use the accumulation version of the fund which meant you don't want to physically receive the interest as cash, you wanted to have it internally reinvested. So as far as they're allowed they will just reinvest the income. But they can't avoid the tax obligations because as their investor, you're 'getting' the income distribution, even if you choose not to get it in cash. The interest has still been earned. So they have to deduct the withholding tax from the 'distribution'.

In an income fund you have £1 deducted off you for each £5 distributed, and would receive £4 instead. This is an accumulation fund not a distributing fund so the £4 is being internally reinvested without you seeing it, but the £1 is still being taken away and given to HMRC instead of being given to you in your hand or in the fund.

So 6% gets earned, but a fifth of it is lost to tax, and then maybe only 4.8% is left to be reinvested.

But hold on a moment, you own this through an ISA which is tax exempt. If you hold the fund through an ISA or a SIPP pension, you are not a taxpayer. So really you shouldn't have to suffer this withholding tax on your interest 'distributions' generated from this high yield fund. Your ISA platform manager will confirm to the fund manager (or to HMRC, however it actually works) that actually you are a non taxpayer and the 20% of the interest should not just be winging its way over to HMRC to be lost forever. It can be claimed back.

So your ISA manager gets back the tax that was deducted from inside the fund and is able to reinvest it for you.

So you started the year with 641.39 units which you paid 124.73p for. Then after a couple of months the ISA manager was able to get 27p in tax which had been reclaimed. This would represent the amount of tax which was deducted out of the fund at the time the interest distributions were allocated to you. The next month he recovers 80p of tax. The next month, 96p. Each time he gets the money in he spends the money on buying you some new units.

The unit price goes up and down with the market - it depends what the portfolio of investments is worth from one day to the next. So the first time he's buying you some new units he only has to pay 123.99p a unit which is less than you had paid a few months earlier. The next month he has to pay 125.37p a unit which is more than what you had paid in July. The price will move all the time. But he will keep buying you new units with whatever money comes in.

So to summarise (with simplified numbers):
Fund takes in £100 of your money for 100 units at £1.00. Money invested for a year and gets 6% after expenses = £6. The fund manager is holding £100 of bonds or other assets, and £6 of cash.

In an Income fund the fund manager pays the cash to you net of £1.20 tax. In an Accumulation fund the fund manager reinvests it for you into new assets, net of £1.20 tax.

So at this point the Accumulation Fund is holding £104.80 of assets on your behalf (which is valued at £1.048 per share, because you have 100 shares) and HMRC has £1.20 in their bank. Your ISA manager reclaims the £1.20 because ISA holders don't need to pay tax. The ISA manager spends the £1.20 value buying more shares at £1.048 per share which is about 1.145 shares. So now in total you have the 100 shares you originally bought and 1.145 new shares for a grand total of 101.145 shares. Each of those shares is worth £1.048, so the total value of your investment at this point is £106.

So, you're getting all your value as promised.

But this assumes that the value of the investments don't fluctuate. In reality they do, daily.

For example I might invest in a bond that pays a fixed £6 a year interest and be willing to pay £100 for it because 6% is a reasonable rate of interest for the risk I am taking ; the bank base rate is only 0.5% but I want 6% from this bond because there is a risk the company which issued it could go bust. The next week, bank base rates go up from 0.5% to 5.0%. All of a sudden my bond paying £6 a year is not so attractive.

If a completely safe bank will now pay me 5%, I might want 10%+ from my bond in this risky company. The bond is paying £6 a year so if that needs to be a 10% return, I only want to pay £60 for it, to make sure I get my 10% return at the end of the year. And then perhaps I hear that another rival company has started up in the same business sector so I have concerns about the profitability of the company that issued the bond, and fear they might not be able to make every future payment on time, if at all. I demand an even better effective interest rate, and decide for this bond paying £6 a year I only want to pay £40 not £60.

So, your high yield bond fund might have gone out and bought a bond at £100 which is now only valued in the market at £40. That would have a large negaive impact on the value of the portfolio and the units which were originally £1 each (and had increased to £1.048 each) might later only be trading at 70p.

So because of effects like this, you can't really say:

but I don't see that from the valuation (above in blue?)? What am I not understanding!

The valuation changes all the time so you can't see your interest earned being directly reflected smoothly in the unit price - because the capital value of the fund's investments can change massively as weeks go on depending on what the market thinks of the investments it holds.

The valuation is based on a unit price of 122.97 on my account yet on the fidelity site the Buy/Sell Price is 122.68. Is that something to do with it or is that just the valuation being a day out?

Probably the valuation is a day out. When you actually buy or sell a unit you will the next calculated price based on what the assets are worth and how many shares are in the fund; it takes time to do the calculation and this is then published with a delay. Your ISA manager will just be displaying a recent price they got from the fund manager but inherently neither of them will be a 'real time' price because price is not calculated in real time let alone published in real time.

Either of them would be 'close enough' to estimate what you might possibly get if you were to put an order in to sell tomorrow, but in reality that could be a percent or two off the current displayed price depending on what happens to the market between the last time they published the price and the valuation time for the sales orders tomorrow.

gingerscot

Thanks guys, much appreciated!

I realise it was an accumulation bond, yes, sorry it wasn't clear at certain points. My confusion was I thought it was paid to me & automatically units were bought with that money. An an income would go into a cash fund of some sort for me to either reinvest or cash out.

Now I understand that I don't see any transactions because the income never reaches me, the bond manager re-invests it himself so to speak, correct?

But I get the ~1% regardless as that's tax so I "see" that transaction as it's to my account.

Looking at the Aberdeen European Bond it seems to have performed;

3 mth 6 mth 1 yr 3 yr
-0.93% -1.46% 2.83% 12.34%

..below expectations though appreciate it's yield may not have been ~6% all that time. Against the sector it's done well enough (well according to what sector they are comparing it to!). Logic would presume that in a perfect world I would see 1.5%, 3%, 6%, 18% above right?

If the above is correct than I suppose I just need to understand that 6% acc is likely to be far more variable that 6% income (if that existed). It's a long term investment I just think psychologically it was always nice seeing a regular transactional re-investment like with the income bond.

Thanks again!

bowlhead99

gingerscot wrote: »

I realise it was an accumulation bond, yes, sorry it wasn't clear at certain points. My confusion was I thought it was paid to me & automatically units were bought with that money.

If the purpose is to accumulate more assets then there is no point paying you the money and have you automatically buy more units with it. It is more efficient more them to just keep the money.

An an income would go into a cash fund of some sort for me to either reinvest or cash out.

If you mean an 'income' as distinct from 'accumulation' fund would pay you the cash for you to decide what to do with, then yes. That's the difference between income and accumulation funds.

Now I understand that I don't see any transactions because the income never reaches me, the bond manager re-invests it himself so to speak, correct?

Yes

But I get the ~1% regardless as that's tax so I "see" that transaction as it's to my account.

Yes, the tax that was withheld from the money that was reinvested on your behalf, is collected by your ISA manager or pension manager and they have used it to top up your holding in the fund, buying more units.

Looking at the Aberdeen European Bond it seems to have performed;
3 mth 6 mth 1 yr 3 yr
-0.93% -1.46% 2.83% 12.34%

..below expectations

Below your expectations perhaps, but perhaps you didn't know what to expect or how high yield bond funds actually work. It seems to have performed quite well, particularly over the last year compared to just investing in the average sterling high yield bond fund which has fallen - some of that may be exchange rate effects as you are invested not just in bonds from UK but also French, German and Italian bonds while the Euro has appreciated against the pound in recent months.

Logic would presume that in a perfect world I would see 1.5%, 3%, 6%, 18% above right?

If by a perfect world you mean a world in which the value of bonds didn't ever change, then yes.

Although, that is overly simplistic - a 6% return would compound up as the money kept being reinvested so would exceed 18% after 3 years. Except of course it wouldn't, because you are paying management fees and other costs to the fund manager for running it, which wipes almost 0.9% off your annual gross performance, so you would not get to the 18%+ ; you'd see 16-17% if you were lucky.

But of course we are not in a world where the value of bonds never changes! The value of bonds does change, dramatically, from time to time. The figures you quote show a 1.5% loss for your fund in the last 6 months despite the fact they probably earned 3% of income which easily covers running costs. For the high yield sterling bond sector as a whole, the average is probably a loss of over 5%, so you have done quite well (probably helped by some currency effects).

See my worked example in the previous post where a bond bought for £100 might still be paying out its £6 per year but could decline in value significantly, so that your bond fund manager might only get £40 for it instead of £100. Losses can be significant. That is why they are willing to pay a high yield.

If the above is correct than I suppose I just need to understand that 6% acc is likely to be far more variable that 6% income (if that existed).

It is not really more variable. If you have the acc version you don't see any income and you see the fund value move all over the place on the charts. If you have the inc version they keep paying out a chunk of money to you but the remaining fund value still moves all over the place on the charts.

High yield bonds / junk bonds are higher risk than fixed deposits or lower yielding bonds, and can move significantly in value as a result of changes in both the stock markets and the interest rate markets.

If you want to benefit from them long term you can reinvest the income (either by using an Inc fund and manually reinvesting, or just by using an Acc fund as you are doing); you will see the value move all over the place with the markets, but hopefully up over the long long term.

If you do not reinvest the income - by having an Inc fund and not reinvesting the money, but taking it out and spending it on something else - you will cause the value of the fund to fall compared to where it would have been if you had left it in there. In that case, the value will still move all over the place because the value of bonds always move all over the place and is now less likely to be going up because you are taking money out and you have the money in your hand instead.

It's a long term investment I just think psychologically it was always nice seeing a regular transactional re-investment like with the income bond.

If that's something you like, you could always sell the "High Yield Bond I Acc" class of shares and buy the "High Yield Bond I Inc" class of shares instead, then manually reinvest whatever gets sent to you. The distributions are at regular intervals and perhaps psychologically it would make you feel happier.

The price of the fund would still be moving about all over the place though. If your fund manager is buying bonds now which pay a fixed level of interest which represents a high premium over the bank base rates, and base rates rise, the premium that they pay to compensate for the high risk will effectively fall, and the only way to make the bonds attractive to a buyer is to drop their price. Which could spell disaster for the value of your fund. It depends how smart the manager is about seeing it coming and managing his portfolio.

Of course, if interest rates rise only very slowly with a broad improvement in economic conditions, and the bonds are held to maturity, then there may not necessarily be any losses. That's the ideal world but it's unlikely to work out so neatly. The inherent risk is why the bond fund is getting a yield of 6% from its investments when the banks are only paying 0.5% base rate on cash deposits (in UK, and even less in Europe)

Chickereeeee

Easiest seen here:
http://www.hl.co.uk/funds/fund-discounts,-prices--and--factsheets/search-results/a/aberdeen-global-high-yield-bond-i-accumulation/charts

Just add the equivalent income fund (Aberdeen European High Yield Bond I Inc) and alternate between Price and Total Return buttons.