Conservative investors often view a higher dividend yield as a good thing, in part because they can get steady streams of income with modest levels of risk. But a significant number of equity mutual funds are taking advantage of this preference by engaging in a strategy that does little to boost total returns and saddles clients with higher fees and tax bills, research suggests.
Lawrence E. Harris and David H. Solomon of the University of Southern California Marshall School of Business and Chicago Booth's Samuel Hartzmark looked at 2,798 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 used dividend capture to make underperforming funds appear more attractive.
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. Especially when times are bad or interest rates are low, investors seem to view dividends as safe, because they provide a steady stream of income in an otherwise uncertain world.
Juicing involves holding a stock only long enough to collect the dividend payment, which can be less than a day. Harris, Solomon, and Hartzmark say fees for juiced funds were higher because they traded more often. The researchers find that higher dividend yields also created excess taxes of at least 0.6 percentage points a year of the total account, and probably more, as the calculation did not include the effects of higher taxes on short-term gains.
Moreover, it appears juicing often leads to worse overall returns for investors. The researchers find that funds with the highest artificial boosts from juicing underperformed the average fund on total returns by 2.1 percentage points.
So why do fund managers do this? The researchers speculate that investors in these funds pay attention to the higher dividend yields juicing produces, but not necessarily to the costs and long-term returns involved in the practice.
Lawrence E. Harris, Samuel Hartzmark, and David H. Solomon, "Juicing the Dividend Yield: Mutual Funds and the Demand for Dividends," Journal of Financial Economics, forthcoming.
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