If you buy a bond the idea is that you get a fixed coupon over the life of the bond and then you get repaid your capital. The fixed coupon bit is where we get the term fixed interest, it's fairly fundamental to the nature of bonds. But when you buy into a fixed interest fund rather than buying an individual bond, do you expect a regular distribution? OK so the amount of the distribution will change over time in a fund but when I buy I invest in the fund do I expect to get something each quarter? I think the answer for most people is yes.
5 major Australian Fixed Income ETF's failed to declare a distribution in June/July. 2 Vanguard ETF's 2 Russell ETF's and a State Street ETF's.
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It appears that there has been something of a perfect storm for these funds. Transaction activity in the funds created losses during the period which was not offset by income and hence the fund has no taxable income to distribute.
Bad luck or bad management. Will these funds outperform in the coming months because they have repositioned their portfolios? Perhaps.
For many investors I think this will be a disappointing outcome. Vanguard points out that they don't expect it repeated over the long term. Could this have been avoided? Clearly others were able to make distributions.
When asked for an explanation Vanguard provided this in relation to VAF:
"Taxable income generated by the fund was offset by losses from transaction activity through the sharp bond market downturn during the June quarter. The fund did pay distributions in the first three quarters of this financial year.
Throughout the course of the quarter, the fund bought and sold securities to facilitate cash flow into and out of the fund. The sale of securities to meet redemptions during the June quarter coincided with the sharp downturn in bond markets. This resulted in realised losses on the sale of these bonds, which offset other income earned by the fund, for example coupon interest. The funds income position for the June quarter was a result of transactional activity in the fund taking place at the same time as the sharp downturn in fixed interest markets. The downturn in bond prices was the result of heightened inflation concerns with yields rising in anticipation of the RBA raising the official cash rate faster and higher than previously anticipated.
These transactions generated losses that are treated as income by the ATO. The losses offset other income that had been earned by the fund which unfortunately means that there is no taxable income to distribute for this quarter.
Vanguards Australian fixed income funds have a track record of consistently generating and paying regular income, with this June quarter being an outlier. We would encourage investors to not overweight any short-term outcome in pursuit of a long-term financial goal.
It is worth noting however that while bond prices fell in light of expectations of rising interest rates, higher rates can be a good thing for bond investors over the long term. As higher yielding securities are purchased by the fund, interest received from those securities will generate higher income for investors in the future.
In our view, the sharp downturn in bond prices combined with the high level of transactional activity that contributed to the funds income position in the June quarter are circumstances unlikely to be repeated over the longer term. Investors may experience variable income distributions over the shorter term in line with volatility within fixed income markets"