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How would you like to invest in a portfolio of Canadian blue-chip stocks that offers a yield of 11.1 per cent?
You can call your broker and buy this security right now. But before you do, read on.
Last week, I received the following question from a reader: "What do you think of funds like DFN-T, managed by Quadravest Capital Management? Is the monthly dividend a return of capital? What are the main risks?"
I did some research and found the fund in question is Dividend 15 Split Corp. It invests in a portfolio of 15 high-quality, dividend-paying stocks, including the major banks, BCE Inc., Enbridge Inc.,Manulife Financial Corp., TransCanada Corp. and others. The manager writes covered call options on the shares in the portfolio to generate additional income. There are two classes of shares: Class A, which trades under the DFN-T symbol, and a preferred share that trades as DFN.PR.A.-T The fund has a termination date of Dec. 1, 2019, although there is a possibility of a five-year extension with shareholder approval.
The preferred shares pay a monthly cash dividend of 4.375 cents (52.5 cents a year). The termination objective (a key word, as we'll see in a moment) is that investors will receive the full initial value of the shares when the fund matures.
The Class A shares pay a monthly dividend of 10 cents ($1.20 a year). Here again, the objective is that investors will receive at least the original price of the shares at termination. At the time of issue in March, 2004, the Class A shares were priced at $15 and the preferred shares at $10.
The Class A shares (DFN) that the reader asked about are currently trading at $10.65. They continue to pay a 10-cent monthly dividend, which means they have a yield of 11.3 per cent.
For tax purposes, in 2015 (the latest year for which information is available), 73 per cent of the payment was in the form of eligible dividends and the rest was treated as a capital gain. So if the shares are held in a non-registered portfolio, you get a tax break.
All of that looks incredibly attractive for a portfolio of blue-chip stocks. There has got to be a catch, right? Yes, there certainly is. I said earlier that management's "objective" is to repay at least the original distribution price. That's an objective, but it is not a guarantee. As of Dec. 31, the combined preferred and Class A units had a net asset value of $19.69. That is well below the $25 that would be required to pay in full both the preferred and Class A shareholders at termination.
If the fund matures at its Dec. 31 value, the preferred shareholders would receive $10 a unit while the Class A investors would get the remainder, or $9.69 a share (I have not taken termination costs into account here).
For Class A investors, that represents a loss of $1.15 from the current valuation, or 10.6 per cent. The market is pricing that loss into the share value, which is why the yield is so high. As always, if the yield appears to be unreasonably high, there's a good reason. By contrast, the preferred shares are actually trading at a premium right now, closing on Jan. 27 at $10.20.
The yield is much lower, at 5.1 per cent, but investors will recover their full $10 at termination. That makes them a much safer bet than the Class A units if you're interested in this fund.
Consult your financial adviser before making any decisions.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to buildingwealth.ca.
Gordon Pape