Split-share corporations come with inherent drawbacks that can hand investors unexpected and unwelcomed costs sooner than they’d planned
Split-share corporations: they’re just one of the areas in which Pat McKeough’s Inner Circle can get our investment research. Members also get to ask investment questions of Pat and his research associates about investing in stocks. AND they get to see all other members’ questions, and our answers (of course, we eliminate any personal information). Members usually ask about stocks they own or are thinking of buying. Some of these stocks are so attractive that we eventually add them to our recommendations. Others are sells. In many cases, in addition to our specific advice, we provide valuable background information.
For instance, one member recently asked us about investing in stocks through split-share corporations, which are a good example of a structured financial product. A split-share fund is one type of structured product that investors may encounter.
Structured products or structured notes are investments that come with special characteristics that make them superficially attractive to investors. However, they tend to be far more profitable for brokers. That’s because, once commissions and other fees come out of these investments, it’s unlikely that you’ll wind up with a profit to match your risk. A split-share fund is an example of a structured product with potentially high fees and risks.
To give you a clear sense of the drawbacks of investing in stocks through split-share corporations, I’d like to share our Inner Circle member’s question, along with our response. I hope you enjoy and profit from it.
Q: Pat: As an Inner Circle Member, I would like to ask about Dividend 15 Split Corp. Thanks.
A: Dividend 15 Split Corp., symbol DFN on Toronto (www.dividend15.com), is a split-share investment corporation that holds shares of 15 companies, including BCE Inc., Bank of Nova Scotia, Thomson Reuters, National Bank of Canada, TransAlta Corporation and Enbridge.
This split-share fund can also invest up to 15% of its portfolio in other stocks.
Dividend 15 Split Corp. has two share classes: Dividend 15 Split Corp. capital shares (Toronto symbol DFN), and Dividend 15 Split Corp. preferred shares (Toronto symbol DFN.PR.A).
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Split-share corporations come with drawbacks
A split-share company issues two classes of shares. Usually, the capital shares get all or most of the capital gains and losses, and the preferred shares get most of the dividend income. In the case of Dividend 15 Split Corp., the capital shares also get any increase in the dividends issued by the 15 stocks it holds.
As a result, unitholders of capital shares get a monthly dividend for a very high yield.
Holders of preferred shares get a fixed monthly dividend.
However, Dividend 15 Split Corp. income does not cover those high distributions to its unitholders. To make up the difference, this split-share fund must realize capital gains on the securities in its portfolio. But those gains are far from guaranteed, so it supports its distributions by selling call options on the stocks it holds.
Selling call options generates an income stream for the company. However, these sales tend to limit any capital gains that Dividend 15 Split Corp.’s portfolio might otherwise generate. That’s because when the stocks that the trust owns go up, holders of any call options on those stocks will buy them from the trust at the agreed-upon price. That means the company loses out on any future price gains for those stocks.
Meanwhile, Dividend 15 Split Corp. needs to hang on to its poor-performing stocks to offset its outstanding call options. Options trading also tends to generate a lot of brokerage commissions; they can eat away at the company’s capital.
The managers of Dividend 15 Split Corp.’s portfolio also aim to keep most of their individual stock holdings in the range of 4% to 8% of the fund’s overall value. That means they will need to rebalance their portfolio’s holdings from time to time. This selling and buying also generates commission expenses.
This split-share corporation faces a looming windup date
The split shares will wind up on December 1, 2024. That’s a drawback to split shares in general, and Dividend 15 Split shares in particular. Unless the windup date is extended, you will be forced to cash in your investment and deal with the tax consequences at that time. You’ll also face brokerage costs to reinvest any proceeds after you’ve redeemed your shares.
Although we like most of the stocks it holds, we advise against investing in either class of Dividend 15 Split Corp. shares.
In summary, split-share corporations, such as Dividend 15 Split Corp., are structured financial products that may seem attractive to investors seeking high yields. However, these investments come with significant drawbacks and risks. A split-share fund typically issues two classes of shares: capital shares, which receive most of the capital gains and losses, and preferred shares, which receive most of the dividend income.
While the capital shares of a split-share fund like Dividend 15 Split Corp. may offer a high monthly dividend yield, the fund’s income often does not cover these distributions. As a result, the split-share fund must rely on realizing capital gains and selling call options on its holdings to generate additional income. This strategy can limit potential capital gains and expose the fund to high brokerage commissions. Moreover, split-share corporations often have a predetermined windup date, forcing investors to cash in their holdings and face potential tax consequences and reinvestment costs.
Despite holding a portfolio of potentially attractive stocks, the structural limitations and risks associated with split-share funds like Dividend 15 Split Corp. make them less appealing for most investors. It is crucial to thoroughly understand the complexities and potential downsides of these investments before considering them for your portfolio.
Does a high-yield distribution increase the appeal of investing in a split-share corporation?
Note: This article was originally published in 2010 and is regularly updated.
Comments
Wheeler
as two drawbacks to dividend split 15, you cite having tax implications and brokerage charges. Consider the even higher yeild from dividend split II and the fact that this investment is in a TFSA. Now there is now tax implications at termination when these are to be redeemed and my final question on the risk is whether my understanding is incorrect with the fund’s objective to wind up the fund and return the shareholders at least the initial share value which in DF.TO’s case (dividend split II) is $15 / share. My understanding was that if they couldn’t close the fund and meet this objective that there would be a motion to extend the fund. This fund has already been extended twice to my knowledge, is there a limit? Is it possible that at the 2019 date it could be firesold at that day’s closing price and contravene the fund objective? Seems like if that were to happen there would be a lot of people jumping ship before then which would in turn destroy the share price in a massive selloff.
I’ve made amazing dividend returns off of this as my TFSA portfolio and with the funds they invest in i am failing to see the risk from a long term investment strategy from the points you have highlighted but also never see any reports from investment research firms on the fund in finance news; only its typical monthly dividend declaration. Open to enlightenment here.
Thank you for your insights. We continue to caution subscribers on drawbacks you’ve summed up nicely. We are glad that you have made it work for you. Thanks again.
Since it takes forever for a comment to be moderated and in the off chance someone reads the above question and it never gets answered, perhaps this will help someone. I read the prospectus carefully and apparently only preferred shares have to be paid at initial purchase price in DF’s case that’s $10 a share. If you subtract that from the present day NAV of about $15.60 that leaves $5.60 per share for every class A shareholder if it were to terminate at that NAV price. Thus if you bought higher than that simple NAV – $10 calculation you are at severe risk for losing a tonne of equity on the termination date which is Dec. 2019 in this case.
I’d say a few months before the last arbitrage date in August would be a safe exit if the NAV – $10 calculation doesn’t rise above your average cost per share. Till then it’s great dividends to take in with a tfsa.
Don’t agree with this advice as far as the preferred share of split corps. For many years I invested in the preferred side heavily putting my fixed income portion in them, and I was rewarded handsomely in comparison to investing in bonds, GIC’s, saving accounts, fixed preferred or money markets. Chosen properly they have excellent downside risk , good liquidity and good return.
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as two drawbacks to dividend split 15, you cite having tax implications and brokerage charges. Consider the even higher yeild from dividend split II and the fact that this investment is in a TFSA. Now there is now tax implications at termination when these are to be redeemed and my final question on the risk is whether my understanding is incorrect with the fund’s objective to wind up the fund and return the shareholders at least the initial share value which in DF.TO’s case (dividend split II) is $15 / share. My understanding was that if they couldn’t close the fund and meet this objective that there would be a motion to extend the fund. This fund has already been extended twice to my knowledge, is there a limit? Is it possible that at the 2019 date it could be firesold at that day’s closing price and contravene the fund objective? Seems like if that were to happen there would be a lot of people jumping ship before then which would in turn destroy the share price in a massive selloff.
I’ve made amazing dividend returns off of this as my TFSA portfolio and with the funds they invest in i am failing to see the risk from a long term investment strategy from the points you have highlighted but also never see any reports from investment research firms on the fund in finance news; only its typical monthly dividend declaration. Open to enlightenment here.
Thank you for your insights. We continue to caution subscribers on drawbacks you’ve summed up nicely. We are glad that you have made it work for you. Thanks again.
Since it takes forever for a comment to be moderated and in the off chance someone reads the above question and it never gets answered, perhaps this will help someone. I read the prospectus carefully and apparently only preferred shares have to be paid at initial purchase price in DF’s case that’s $10 a share. If you subtract that from the present day NAV of about $15.60 that leaves $5.60 per share for every class A shareholder if it were to terminate at that NAV price. Thus if you bought higher than that simple NAV – $10 calculation you are at severe risk for losing a tonne of equity on the termination date which is Dec. 2019 in this case.
I’d say a few months before the last arbitrage date in August would be a safe exit if the NAV – $10 calculation doesn’t rise above your average cost per share. Till then it’s great dividends to take in with a tfsa.
Don’t agree with this advice as far as the preferred share of split corps. For many years I invested in the preferred side heavily putting my fixed income portion in them, and I was rewarded handsomely in comparison to investing in bonds, GIC’s, saving accounts, fixed preferred or money markets. Chosen properly they have excellent downside risk , good liquidity and good return.
Thanks for your views on the preferred shares of split-share corporations.