How investment funds disguise underperformance
Equity mutual funds artificially boost their dividend yields to attract more investors
- Conservative investors often view a higher dividend yield as a good thing. A significant number of equity mutual funds are taking advantage of this preference by trading in and out of stocks to quickly capture dividends, according to research by Lawrence E. Harris and David H. Solomon of the University of Southern California Marshall School of Business and Chicago Booth’s Samuel Hartzmark. But the strategy does little to increase returns and saddles clients with higher fees and tax bills, they argue.
- The researchers call the practice “juicing,” as its intention is to add gusto to an otherwise normal-looking dividend yield when a fund doesn’t stand out based on other characteristics, such as returns.
- The researchers looked at 2,789 funds that paid dividends between 1990 and 2011, for a total of 13,221 observations. They find that funds in about 20 percent of these observations juiced their dividend yields to make underperforming funds appear more attractive.
- Funds that juiced their dividends attracted more investment flows compared to similar nonjuicing funds (see chart). But the practice is costly to investors. Juicing involves trading stocks often—holding a stock long enough to collect the dividend payment—resulting in higher fees. Juicing also results in higher taxes (dividends are generally taxed as ordinary income) and often leads to worse overall returns, according to the researchers.