The arrival several years ago of managed payout mutual funds promised to simplify retirement income decisions, at least for clients seeking income from their fund portfolios.
The funds offered a variety of structures and portfolio holdings.
Some were designed for finite terms and anticipated liquidation by a specified date while others planned to generate income indefinitely.
Fund sponsors stressed that payouts were not guaranteed and would vary with investment results.
Nonetheless, the idea’s simplicity and convenience were appealing: Invest in this fund and we’ll manage it to give you a monthly distribution. If you have a targeted distribution rate, you can invest in a fund that pays out at that level.
The financial crisis set back the funds but several have done well with the markets’ subsequent recovery. They’ve produced solid results and earned high ratings from Morningstar. Still, investors haven’t really bought into the concept and most of the target payout funds remain relatively small.
For example, Vanguard initially offered three managed payout funds with 3-, 5- and 7-percent distributions. The individual funds attracted only modest amounts—by big fund company standards, at least—and in early 2014 the firm merged the three funds into the Vanguard Managed Payout Fund (VPGDX). The combined fund has roughly $1.5 billion in assets and targets a 4 percent payout rate.
I asked John Ameriks, a principal and head of the Active Equity Group within Vanguard Equity Investment Group in Valley Forge, Pennsylvania, about the revamped fund. He explained that the fund was designed with a methodology that borrows from “how endowments think about their spending and structure of their portfolios over time.”
As of June 30, the fund held 75 percent of its assets in stocks (in the form of Vanguard index funds), 20 percent in bonds and just under 5 percent in commodities.
Investment decisions are based on qualitative and quantitative asset allocation analyses and the fund’s spending targets.
“There is a baseline quantitative analysis that involves looking at our projections for what different asset class returns are going to be over long periods of time, what the correlation between those asset classes are and then metrics of risk and return relative to our spending targets,” he says. “That procedure establishes a frontier of different options that if we allocated the fund with this particular configuration we would have this probability of achieving goals and this risk of a decline in payments.”
A review of the fund’s distributions for 2013 and 2014 show that roughly one-third of each payment has been a return of capital. Ameriks agrees that this result can confuse advisors and investors but stresses that it’s an accounting issue and not an indication that the fund’s results can’t support the distributions. The fund’s total recent returns have exceeded the payout: 11.02 percent in 2012, 15.97 percent in 2013 and 4.78 percent through July 31, 2014.
So how should advisors consider using a managed payout fund? Ameriks believe the fund can complement guaranteed sources of retirement income and be used to created disciplined but flexible distributions for discretionary expenses. “You’re still able to turn the distributions off if you find you don’t need them over time, to make ad hoc withdrawals if you do need more income or to cash the entire balance out if a large lump sum expenditure comes along,” he says.
Fidelity and Schwab also offer managed payout funds. For advisors and retirees seeking that mix of flexibility and discipline Ameriks describes, these funds could be a viable option.