By Scott Ronalds

It’s stingy times for income investors. Government of Canada bonds are yielding less than 2% (5-year maturities are at 1.3% and 10-year maturities at 1.8%) and high quality corporate bonds are only 1-1.5% higher. Dividend-paying stocks are paying relatively attractive yields, but come with greater risk.

All of this to say that income-focused investors should be prepared for lower income payouts on their funds, and in some cases distribution cuts. Products that pay distributions north of 5% are most at risk. In today’s environment, it’s simply not feasible for a fund to pay out such a high distribution without (1) investing primarily in junk bonds or high-yielding stocks (which comes with its own set of risks), or (2) returning a portion of the original investment (known as return of capital, or ROC).

A case in point is the $4.3 billion BMO Monthly Income Fund. The fund, which invests in a combination of bonds and stocks, has been paying a monthly distribution of $0.06/unit, which equates to an annual yield of close to 10%. Industry expert Dan Hallett (HighView Financial) has been writing about the fund for two years (as have we) and has questioned the sustainability of its distribution. Well indeed, in a post last week Dan highlighted that BMO intends to cut the distribution by 60% to $0.024/unit. He noted that this is a good news/bad news story – good because it will improve the sustainability of the distribution; bad because it will hurt investors who have come to rely on the payout.

This brings us to the Steadyhand Income Fund. This fund has historically paid a fixed distribution of $0.10/unit for the first three quarters of the year (March, June, September) and a variable year-end distribution which has ranged between $0.10 and $0.53/unit. In annual terms, the distributions have added up to a yield of between 4% and 8%.

In determining the fixed distribution, we try to anticipate the interest and dividend income that the fund will generate over the year, as well as the amount of capital gains or losses that may be realized. We’re trying to find a balance between conservatism (we don’t want to have to lower the year-end distribution) and not having excessive gains build up in the fund. Picking a distribution rate is more art than science due to the variability of capital gains/losses.

We feel the Income Fund’s current quarterly distribution of $0.10/unit is appropriate for the time being. The fund’s pre-fee yield is running around 3.5%. While there is no guarantee that capital gains will supplement the interest and dividend income, the fund is in a strong position in this regard. As always, we will revisit our estimates throughout the year to determine if the fund is still on track to meet its payout. If the yield on the portfolio drops further and/or we determine that the fund is unlikely to generate any capital gains, we will cut the distribution. (Note: The Founders Fund, which currently pays a fixed quarterly distribution of $0.05/unit plus a variable year-end payment, is in the same boat.)

Investors in our Income Fund and Founders Fund who take their quarterly distributions as cash payments (rather than reinvesting them into additional fund units) should thus be prepared for a potential distribution cut as a reflection of the current low interest rate environment. Again, these are stingy times for income investors.