Income & Dividend Investing

Re: Not Doubting El Lobo :)

helmut — Wed, 24 Oct 2007 22:18:26 GMT

ElLobo...

We had the same argument on the AF forum concerning CAIBX because someone said that the dividend paid by CAIBX was not reflected by a drop in the NAV and assumed that the dividend was never part of the NAV. IT took five men and a fifth of whiskey to find someone high enough on the food chain to give us the right answer.

The way mutual funds are constructed collected dividends are part of the NAV until they are declared.When they are declared they are subtracted from the NAV. Whether you use the word declared or accrued I would be willing to bet a dollar to a donut (not as meaningful a bet as it once was) that the accrued daily dividend is subtracted from the NAV daily.

By the way I called Vanguard again to ask them about the default rate of VWEHX. This time I got someone that no idea what I was talking about and after some hesitation was told that VWEHX had never had a default.

helmut

Re: Not Doubting El Lobo :)

ElLobo — Wed, 24 Oct 2007 20:43:12 GMT

"The Fund's income dividends accrue daily and are distributed on the first business day of every month."

I understand. I don't think 'accrueral' means subtraction from the NAV. That was my only quibble, with your trivia! 8-)

I have never sold shares of this fund since I've owned it. I have only purchased shares, and at different times during the month. I remember receiving only part of the interest distribution, and a quick check, with Vanguard, said that was due to holding those shares for a part of the month, not the whole month.

Re: Not Doubting El Lobo :)

helmut — Wed, 24 Oct 2007 20:14:10 GMT

El Lobo...

Straight from the VWEHX prospectus

"Fund Distributions

The Fund distributes to shareholders virtually all of its net income (interest lessexpenses) as well as any net capital gains realized from the sale of its holdings. The Fund's income dividends accrue daily and are distributed on the first business day of every month; capital gains distributions generally occur annually in December. In addition, the Fund may occasionally be required to make supplemental distributions at some other time during the year. You can receive distributions of income or capital gains in cash, or you can have them automatically reinvested in more shares of the Fund."

helmut

Re: Not Doubting El Lobo :)

ElLobo — Wed, 24 Oct 2007 19:20:01 GMT

helmut,

"The declared dividend is subtracted from the NAV on a daily basis . . . ."

I may be mistaken, but I don't think this part is true. The NAV is the sum total value of all bonds held by the fund. Whenever a bond makes a coupon payment, the value of the bond doesn't change.

I do know that, if you buy or sell shares during the month, at the end of the month (for purchases) and on the day you sell, you receive your part of the total interest earned during that month.

I also don't know if the fund keeps track of the day, during the month, whenever interest is received. For example, if all of the bonds paid their interest on the 25th day of the month, but you sold your shares on the 20th, would you receive any of that interest?

My guess is that they divide the total interest earned during the month by the number of days, so they smooth it out.

Re: Not Doubting El Lobo :)

helmut — Wed, 24 Oct 2007 16:31:52 GMT

El Lobo...File under useless trivia...

Now, in addition to not knowing the asset mix of each fund (BIG uncertainty), there is another unknown. Whenever VWEHX makes a monthly interest distribution, the fund NAV doesn't drop by that amount, like it does whenever it, or any other fund, makes a CG distribution. What that means is that the fund 'accrues' interest it receives during the month, then first divides the monthly total interest received into daily amounts, in order to correctly apportion that interest to those who buy and sell shares during the month.

Your description of daily dividend declarations is pretty close, but if VWEHX works the same way most bond funds do, they declare and credit the dividends daily. The declared dividend is subtracted from the NAV on a daily basis and put into an interest bearing account until the monthly dividend is distributed (some funds that declare dividends daily like CAIBX distribute quarterly) so you would need a microscope to measure the actual daily reduction in the NAV.

helmut

Re: Not Doubting El Lobo :)

Avalon — Wed, 24 Oct 2007 15:12:22 GMT

"That was why I qualified my answer to say that BOTH funds (5% and 7%) used exactly the same invidicual assets, in exactly the same proportions"

I called yesterday and each of those three fund allocations will be 'different'.

Marshall

Re: Not Doubting El Lobo :)

ElLobo — Wed, 24 Oct 2007 13:59:05 GMT

Bill,

It's really hard to theorize whether one fund, and a particular withdrawal strategy for that fund, will be better than, or worse than, another fund and strategy, existing or otherwise. That was why I qualified my answer to say that BOTH funds (5% and 7%) used exactly the same invidicual assets, in exactly the same proportions. Even under this assumption, it's difficult to just think about these effects.

For example, in your followup, you talked about the importance of realized, and unrealized, capital gains, and I recognize that we both tend to think of capital gains as another source of income from a fund, similar to yield. But, as I understand both of the Vanguard funds, the way they are going to operate (calculate their distributions) is quite a bit different then I do it.

Remember, I simply gather all yield distributions in a money market, take my withdrawal from it, then reinvest what's left. As I understand it, Vanguard will, figuratively, reinvest all yield and realized gains back into individual fund assets, then, once a month, take 5%, or 7%, of the average of the last 3 fund NAVs, divide by 12 months in a year, and reduce the current fund NAV by the result, and make their distribution to each shareholder.

Some shareholders will automatically reinvest all of their distribution back into the fund, some won't. Those that do will see absolutely no drop in the VALUE they hold in the fund. This is the 1% drop in NAV (for a capital gain distribution) resulting in 1% more shares being owned philosophy.

Now, if both funds had the same asset mix in the same proportion, then it seems reasonable that reinvesting all of the distribution for both funds would lead to exactly the same result (portfolio value wise) over time. True, the 5% fund would have a higher fund NAV than the 7% fund, but you would own more shares of the 7%.

If that's true, then taking out 5% from both funds (your original question) would also be a wash.

More importantly to your question, the fund NAV doesn't drop by that amount. So, if Vanguard uses this method of accounting in both of their new funds, not only would the asset mix and proportion of each be the same for both funds (my first assumption), the NAV behavior over time would also be the same! And if THAT were true, you would be better ahead to take 5% from the 7% fund and reinvest the difference, to take advantage of the compounding effect.

Anyhow, these were the thoughts running through my head. That is, without knowing anything about the mix of assets each fund will use (other than generalities), and without knowing anything more about how Vanguard will calculate those distributions, I couldn't really say one way or another whether one fund and strategy would be different than another.

If I were the fund manager, I would manage the fund to keep the yield of each above the rate of distribution. That would allow both funds to avoid touching principle, a goal of each.

Re: Not Doubting El Lobo :)

bilperk — Wed, 24 Oct 2007 13:14:08 GMT

ElLobo:

"Take the 5% fund and let the NAV rise or take the 7% fund and reinvest 2% back and get more shares at a lower NAV?"
I would ALWAYS take the one with the higher yield. If the specific investments held by the two funds were the same, as was the AA, then the TR would be the same. My gut feel is that either method (in your question) would lead to exactly the same result, withdrawal wise and portfolio value wise.

I understand you would always take the higher yield, but we aren't talking about yield here we are talking about distribution of a small amount of yield and capital gains, and perhaps even some principal.

So I'm asking if you see any advantage ( perhaps mathematically) in taking more of the capital gains as they are generated and reinvesting them at a lower NAV, as opposed to keeping more of the CGs in the fund.

It would seem to me the 7% fund will have to "realize" more CGs and that would amount to 2% more shares if reinvested. Even though the shares are at a lower NAV, the yield of the underlying equities will not change, so by owning more shares wouldn't you be generating a larger and larger portion of the future distribution from yield?

And if yes, wouldn't a decline in equities of 10% for both funds result in a higher value for the 7% portfolio due to a higher positive yield as opposed to a negative capital gain for the 5% fund?

If not, then isn't this whole "seed corn" thing just an illusion?

best,

Bill

Re: One last thing

egyhazy — Tue, 23 Oct 2007 23:27:56 GMT

I can't believe that you guys are still wasting your time with El Lobo's insane high yield bond scheme.

One last thing

mathguy2 — Tue, 23 Oct 2007 21:36:05 GMT

"You have history, and history says only 2 bonds defaulted. You have a theory that the rise, and fall, of the creditworthiness of the rest somehow magically led to the 1.2% loss. I say you have no idea why the fund lost that amount, because funds experience losses due to all kinds of activities, that helmut's reference outlined."

That's why I pointed out that the six investment grade bond funds had not suffered any loss of initial investment made at inception (while withdrawing 100% of the income distributions) -- these funds experienced all the activities outlined in helmut's reference and didn't lose principal. It is only the two funds where creditworthiness is an issue (VWEHX and PRHYX) that had pronounced losses of the initial investment while withdrawing 100% of income.

Are you suggesting that VWEHX systematically purchased high coupon bonds at a premium, and the amortization of this premium drove down the NAV? That's even worse in my opinion. It's a dishonest attempt to fool people who focus solely on current yield.

Sometimes you need to look at the facts and apply a little deductive reasoning.

ADVDX redux

mathguy2 — Tue, 23 Oct 2007 19:06:42 GMT

"You have no 'evidence', as you call it, that the funds losses were anything more than the second and third reasons I gave a few posting above. You can conjecture all you want."

Gee, where have I heard that before? Oh yeah, El Lobo said it after I posted the details of two special one-time dividend capture investments that accounted for something like 15% of that year's ADVDX income distributions (except he said "BS" instead of "conjecture".)

I'm not a high yield disciple and won't go to the lengths that those who are do to defend their beliefs. I'm not against high yield investing either -- I just want to understand it -- and if it doesn't hold up, it doesn't hold up. My conjecture is consistent with all the data that I've presented. As you may recall from the ADVDX threads, I lose interest in these arguments after all my outstanding questions have been answered. So, I'm going to go read the article I linked to earlier to see what bearing it has on the new managed payout fund.

One last thing -- helmut wondered if my "conjecture" about VWEHX had any implications on the equity side. I have begun to look at the Ken French 1927-2006 portfolio data by dividend yield deciles that I brought to JWR's attention last spring. I'll start a new thread on this if I find anything interesting -- even if it supports El Lobo's theories!

Re: Not Doubting El Lobo :)

ElLobo — Tue, 23 Oct 2007 18:54:36 GMT

"Take the 5% fund and let the NAV rise or take the 7% fund and reinvest 2% back and get more shares at a lower NAV?"

I would ALWAYS take the one with the higher yield. If the specific investments held by the two funds were the same, as was the AA, then the TR would be the same. My gut feel is that either method (in your question) would lead to exactly the same result, withdrawal wise and portfolio value wise.

Re: Vanguard's Managed Payout funds

helmut — Tue, 23 Oct 2007 17:48:14 GMT

bilperk:
There are a lot of things we don't know about these funds at this point. On of the big things to me is if they will be three different AAs with three different payouts or if they will have the same AA in all three funds.
Lets assume that they have the same AA for a minute.
If you want a 5% distribution where your principal grows with inflation, would you choose the 5% fund and let the NAV rise with inflation or would you choose the 7%, and reinvest 2% to increase shares resulting in the same portfolio value but a lower NAV?
Wouldn't your payouts likely increase with the latter over time, visa vie the 5% fund?
best,
Bill

Bill...good to hear from you again. El Lobo has been ask this question in several different forms, several different times, but continues to ignore it.

One answer would make no sense unless you can predict the future using past performance, and the other answer would be an admission that there is no difference in risk between a total return type of distribution and a dividend distribution of an investment that requires a partial dividend re-investment.

Neither answer would square with his high yield hypothesis.

helmut

Re: Not Doubting El Lobo :)

bilperk — Tue, 23 Oct 2007 17:32:31 GMT

El,

I had a great time in NC mountains. Fall colors a little off this year due to hot weather and drought (they say), but still a lot cooler than the 90 degrees we continue to have in SW Florida.

I agree with your points above. We can't know with the data available, which is why I was careful not to make any declarative statements.

As you know, I also own HIY fund, but I do so for that " different assets with the same expected return that are not perfectly correlated" thing. I'm in the Rick Ferri camp that says bond holdings should be diversified just like equity holdings, as opposed to the Swedroe camp that eschews hybrid holdings and prefers to take his equity risks on the equity side and keep his bonds short.

I also like the extra income, and will look for opportunities to purchase more when the yields get up near 8% or above.

The bottom line for me is that the fund has a 9+% total return over almost 30 years and to me the best predictor of future bond fund returns is past bond fund returns. If I can get 9% over the next 30 years, I won't complain.

By the way, have you given any though to my question above:

Take the 5% fund and let the NAV rise or take the 7% fund and reinvest 2% back and get more shares at a lower NAV?

best,

Bill

Re: Doubting El Lobo

ElLobo — Tue, 23 Oct 2007 16:49:34 GMT

Bill,

How was the vacation?

"especially HIY "lite" would be more interest rate sensitive than investment grade intermediate bonds of similar duration."

Bond funds of similar average duration have the same sensitivity. That's what duration means. However, that sensitivity is to the underlying rate of interest. That is, HIY funds are sensitive to changes in HIY rates, while investment grade funds are sensitive to investment grade interest rate changes.

Now, that average duration, from a mathamatical standpoint, is the first derivitive of the yield curve, and the HIY curve is above the investment grade curve. That is, for any given maturity, HIY pays a higher rate than investment grade, because they are riskier. Therefore, at any given maturity, the duration of the bond is higher, for HIY, than for investment grade.

So, if a HIY fund has the same duration as an investment grade fund, then the average maturity of the HIY fund will be lower than the other.

Anyhow, this probably makes little sense to you, however, I wrote this more for Mathguy, who knows derivitives!

"Anticipation of either default or a lower credit rating MAY be significant factors in long term NAV erosion."

I agree. That's why one would have to analyze all of the VWEHX holdings over it's 29 year history, to determine if this was a significant factor, or not. That is, if it caused the 1.2% loss, or 0.1% loss!

However, to assume, as some do on this forum, that a long term drop in NAV for a high yield bond fund is somehow a 'characteristic' of HIY debt is a bit of a stretch, IMHO.

You CAN get some idea on the size of this factor by examining capital gain distributions for the fund. It has made a few in the past, but hasn't done so since I've owned it. Anyhow, if the fund realizes a gain on any bonds that it buys, then sells, it's required to pay the gain out to shareholders. If it realizes a loss, it, obviously, can't distribute a loss.

However, it can 'bank' those losses to offset gains in later years. I am not an accountant, and I certainly don't know how funds do their taxes, but I would think the VWEHX annual report might contain any losses that it has accumulated/banked. It would be interesting to see how much, on a per share basis, is in the bank.

I don't particularly care what that number is, but I assume the fund manager knows full well, and manages the portfolio in a tax efficient manner.

By the way, if the 1.2% loss was explained by this change in credit quality, than any gains, like that over the last 5 years, would also be explained!

Again my point is that one needn't know what caused the erosion, just be aware of things that you can do, to guard against further erosion. That is, what you can do to minimize this particular risk. The primary, safest, thing is to make up for it with some of the yield.