Corporate actions where the cost of an investment is reduced!! Eh????

FDa65rdk

At the end of September 2017 and 2018 there were 'corporate actions' taking place in the Jupiter India fund.

In both cases the cost of my investment was reduced!!!!

I don't understand this. How can the amount paid for something be reduced retrospectively??

If I buy a watch for £100 and sell it for £200, I've made a £100 profit.

I can't say that I actually bought it for £50 and convince myself I made a £150 profit.

What is the justification for these 'corporate actions'?

This is with Hargreaves Lansdown if that helps.

bostonerimus

FDa65rdk wrote: »

At the end of September 2017 and 2018 there were 'corporate actions' taking place in the Jupiter India fund.

In both cases the cost of my investment was reduced!!!!

Have a look at when the dividends were paid. I bet the price of the fund was adjusted down after the dividends were paid. You investment has not changed in value even with the lower price as you have the dividend. Of course you could actually lose money if the fund has longer term price drops from poor performance of the individual company shares it owns.

bowlhead99

Longer answer than Boston's above - I think he is thinking of your value being reduced but actually your complaint / problem is that it is your reported cost being reduced:


The most common reason for this to happen in an open ended fund is what is known as 'equalisation', which sounds complex but is not too bad to get your head round when you break it down.

Some investors will own their entire shareholding for the whole year, but other investors buy into the fund during the course of the year - so that for those latter investors, some or all of the shares they're holding at the end of the year haven't been held for the full twelve months.

When they get to the end of the year, the manager needs to pay out the fund's income to its owners and when doing so, they need to make sure everybody gets the same amount of cash per share (because the shares always have to be 'worth' the same amount each, so they can't pay bigger distributions out of some shares than others). They may decide the correct amount of distribution is (e.g.) £5 per share and will pay this out on the distribution date.

However, the fund's income was 'earned' over the course of the entire year as dividends or interest arrived in the fund's bank account on a daily basis from the investments it holds. If you held your shares in the fund for the whole year, then you did earn the full £5 of income. However, if you only bought into the fund part way through the year, you didn't earn the full £5, because some of it was earned before you got there.

In the case of buying-in part way through the year, some of the price you paid to buy your shares was just for the money that's already sitting in the fund's bank account ready to be paid out to investors within the £5 distribution at the end of the year.

For example, at the beginning of the year, the fund is worth £100 per share. Over the course of the year, it receives dividend income from its portfolio companies (say, £5 per share) which arrives in its bank account over time so that at the end of the year the fund is worth £105 per share. Then it pays out £5 of its cash as a distribution, so the remaining assets of the fund are worth £100 per share again, and the next year starts. This is assuming for simplicity that the portfolio companies it owns don't actually go up in value, and just looking at the income side of it.

You as an investor might buy in at some point during the year, when the price is more than £100, but less than £105. Say you pay £103 for your shares and then over the next four or five months the fund earns another £2 per share of income, so that the total value of the shares ends up at £105 just before the annual distribution day. When they do their cash distribution of £5, they have to give the same amount to everybody, but it is clear that you have not actually 'earned' £5 of income that you need to pay income tax on. Really you only earned £2.

So what they do is - when they send you the £5 at the end of the year - on the distribution notice they say you are getting £2 dividends and £3 equalisation payment.

The £3 is basically to equalise your position with everyone else and recognise the fact that when you paid £103 to buy a share of all the assets in the fund, part way through the year... it was only really £100 of investment assets which existed at the start of the year, and £3 of assets resulting from recently-received income which was earned by someone other than you. So when they give you the year-end fiver, you are getting back the £3 of income that you bought, along with the £2 of income that you earned. The £3 coming back to you is just a return of your cost, and isn't considered to be earned income.

Whereas, if you had owned all of your shares for the entire year, when you get the fiver at the end of the year, that's £5 that you did actually earn, no need for messing around with what you bought vs what you earned.

So each share in the fund will be earned by one of two groups of people: the people who held the share all year and get a full dividend; and the people who only bought it part-way through and get a partial dividend and partial return of cost.

In reality, some people will buy in the early part of the year and earn 'most' of the dividends, some people will buy in the last week of the year and hardly earn any of the dividends, some people will join when exactly 50% of the dividends have been earned and should get £2.50 of the £5, and so on... but it is not feasible to track this level of detail on hundreds of groups of shares. So for administrative convenience it is agreed that they will do an averaging calculation based on the average amount of dividends earned on the shares which existed for less than a full year. So whether you came to the party quite early or quite late, those shares will ALL get (e.g.) £2 of dividends each, unless you already had the share in the fund at the start of the year in which case you get the full £5.


So, once it's understood that sometimes you can be allocated a 'return of cost' rather than an 'income' by the fund manager, you can see how it makes sense for your base cost of investment to reduce sometimes, if you are buying shares in between distribution points. If you held the exact same amount of shares the whole year and never bought any new ones, there is nothing to amend. But if you buy £103 of shares in the middle of the year and then get allocated a £5 distribution they will use that opportunity to tidy up the records and say you paid £103, but got £3 back leaving £100, and separately you got £2 dividend income which you'll see in your consolidated tax statement at the end of the year.

In essence, the "how can the amount paid for something be reduced retrospectively?" is because they don't know until the end of the year when they do their accounting, exactly what the dividend / return of cost split will need to be ; they have to see how much income was earned and how many investors have joined the fund vs exited the fund.

When you come to sell out of your shares in a few years time it might be that you bought in at £103 and sold out at £250 and you are thinking to yourself that you made £147 capital gain to tell the tax man. However, what your fund platform is doing for your convenience is telling you that actually: although you paid £103, you got some of that back pretty quickly (£3 return of capital alongside £2 of dividends in the first year)... so you only paid £100 for what you are now selling at £250... and have made £150 capital gain.

If you are doing this inside a tax wrapper such as an ISA or SIPP, then it doesn't really matter what gains or losses or incomes you made for tax purposes and what they say your cost was, because there are no income taxes or capital gains taxes to pay anyway, but you generally expect their system will report the transactions consistently, regardless of account type.


The above explanation is the most common reason why the cost base needs to get adjusted sometimes. There could potentially be other types of corporate actions which reduce the cost per share (e.g. stock splits etc) but relatively uncommon. Usually you would get a notice of the corporate action in the notices / documents / reports part of your online account, if it is something other than equalisation.

ColdIron

What Corporate Action event type was it? There are over 70 possibilities. Given the fund distributes dividends annually and the payment date is at the end of September I'm guessing you purchased units between ex dates so it was an equalisation payment

Essentially you paid for the dividends accrued from the underlying holdings before your point of purchase in the unit price you paid. It would be unfair to expect you to pay dividend tax on this so the money is treated as a 'return of capital', hence your tax 'cost' is reduced. You will see it if you look under Transaction History and the Income and Loyalty Bonus tabs as an Equalisation payment with the format below

<Fund Name>
Eql - UT Cash Payment

If you don't buy any more units between now and the next ex date next you won't see any more equalisation payments as everything will be treated as a dividend. If your fund is in an ISA or SIPP it's all academic anyway

https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg57705

bostonerimus

bowlhead99....very interesting. I haven't run into this sort of thing in the US.

londoninvestor

ColdIron wrote: »

You will see it if you look under Transaction History and the Income and Loyalty Bonus tabs as an Equalisation payment with the format below

<Fund Name>
Eql - UT Cash Payment

For income units, that's what you see.

For accumulation units, you won't see it like that in the Transaction History as no actual cash payment is involved. However, (a) you see it as an adjustment to your cost, as you've noticed; and (b) for unwrapped holdings (i.e. not in an ISA or SIPP) you get a table in your end-of-year investment report showing the dividend and equalisation amount for each dividend "payment".

For accumulation units in ISAs and SIPPs you don't get that table, but as ColdIron says, in that case it makes no economic or tax difference.

FDa65rdk

ColdIron wrote: »

What Corporate Action event type was it? There are over 70 possibilities. Given the fund distributes dividends annually and the payment date is at the end of September I'm guessing you purchased units between ex dates so it was an equalisation payment

Thank you for your response. It doesn't say what type of corporate action it was.

All you can do is hover the mouse of where it says 'corporate action' where it says that if there has been an adjustment to the cost figure then in most cases it will be an equalisation payment.

FDa65rdk

Thanks bowlhead for taking the time to reply to the message and explain things in such detail.

It's much appreciated.