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| Managed Distribution Policy |
What It Is:
A managed distribution policy is an issuer's commitment to make a fixed periodic
dividend payment. This means investors can buy shares of a security with the
confidence that they will receive a reliable distribution instead of a
constantly changing payment.
How It Works/Example:
Let's assume Company XYZ pays a quarterly dividend on its common stock. Although
the board of directors can choose to pay a dividend in proportion to the profits
for the quarter, the board might adopt a managed distribution policy. This way
the firm pays $1.00 (or any amount it chooses) per quarter, per share no matter
the amount of Company XYZ's profits.
Accordingly, if Company XYZ produces record profits in a quarter, the
shareholders will still receive just $1.00 per share in dividends. Likewise, if
profits do not meet expectations, shareholders do not face the prospect of
receiving lower-than-expected dividends.
Many closed-end mutual funds, which distribute most of their income to
shareholders in order to avoid taxation, adopt managed distribution policies.
This often makes their share prices more stable.
This same notion applies to corporate
dividend payers as well. For them, adhering to a managed distribution policy
when cash flow isn't what was expected may require maintaining an increased cash
position (and thus investing less in return-producing activities), borrowing
money to pay the dividend, or selling assets to do so. In all three scenarios,
this leaves a smaller asset base for the issuer to generate future income.
Why It Matters:
Managed distribution policies mitigate risks for both issuers and investors by
reducing uncertainty. The issuers get a fixed, predetermined expense, and their
share prices are often more stable. The investors get reliable income that is
not so dependent on fickle quarterly performance. This arrangement is
particularly attractive to income investors who depend on dividends to meet
their living expenses or other cash flow needs.
It is important to note that the management of a mutual fund or the board of
directors of a company can always decide to change or eliminate a managed
distribution policy, especially during hard times. However, some boards are
hesitant to do this, because the existence of the policy often lends support to
the stock's price.
Some studies indicate that closed-end mutual funds with managed distribution
policies trade at smaller discounts to their net asset values, and sometimes
they even trade at a premium due to this policy. The important thing to remember
is that although managed distribution policies may lead to predictable cash
flows, they do not mean assured cash flows.
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