Before we cover equalisation, here is a quick refresher on what is meant by a fund "going ex-dividend".
This term refers to the period between the ex-dividend (XD) date and the payment of the dividend. If you sell the fund on the XD date or during the XD period, i.e. when the fund has gone ex-dividend, you will still be entitled to the dividend payment. If however, you sell a fund before the XD date, the dividend will be paid to the new owner of the fund.
Many funds receive dividends from the companies in which they invest. These payments are added to the fund’s cash reserves and held there until they are paid out as dividends to the fund’s unitholders. As the reserves grow, so too does the fund’s net asset value causing the offer price for the fund’s units to increase in-line (ignoring market fluctuations).
When the fund’s next dividend payment to its unitholders becomes due on the XD date, a sum is set aside and is no longer part of the fund’s cash reserve. Consequently the unit price usually falls.
With equalisation, investors are split into two groups:
All unitholders, both Groups 1 and 2, receive the same dividend per unit. The difference is that the payment for Group 1 is entirely comprised of income whereas the payment for Group 2 unitholders is split into two components. As Group 2 unitholders have purchased units between the dividend dates, part of the payment is the income which has accumulated from the date of purchase. The other is a partial return of the amount paid as they bought units at a higher price. This latter part is known as a capital repayment or an equalisation payment.
This is the XD date for our example fund. Group 1 unitholders (those who purchased before this date and still hold their funds) will receive the full dividend payment as income.
Any investors who purchase units on this date will be Group 2 unitholders and will have to wait until the next distribution date before they receive a dividend payment. This payment will be income only; there will not be an equalisation part as they have invested at the start of the period.
Assuming there is no market movement, an investor purchasing units between the ex-dividend dates will pay a higher price due to the dividends accumulated from the fund’s underlying investments. These investors will be classified as Group 2 unitholders and they will receive the next dividend payment. As they have purchased units exactly at the midpoint between the two ex-dividend dates in this example, their dividend payment will be split 50:50 between income and capital.
Purchasers of units on this date will be Group 2 unitholders and entitled to the next dividend payment. This will mainly be a capital repayment.
This is the next XD date for the fund. The price drops to reflect that the dividend sum has now been set aside ready to be paid out and is no longer part of the fund’s cash reserves.
On the XD day, those unitholders who were previously Group 2 now become Group 1 unitholders and, as such, receive the full dividend payment as income.
There are no tax implications for investors who receive equalisation payments if they hold their funds within tax wrappers such as ISAs.
Unitholders whose funds are held outside of one of these tax wrappers, however, need to be aware of the tax treatment of the different elements of the dividend payment.
The income part is subject to income tax in the usual way.
The equalisation (or capital repayment) part needs to be considered when calculating any future gains as it has to be deducted from the purchase price of the holding.
|Purchase cost of holding||£5,000 of units purchased|
|First dividend received after 2 months||£150 (£100 is equalisation payment and £50 income)|
|Sale proceeds after 3 years||£8,000 of units sold|
|Equalisation payment deducted from purchase cost of holding||£5,000 - £100 = £4,900|
|Capital gain calculation||£8,000 - £4,900 = 3,100|
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