What is a Managed Distribution Policy?
A managed distribution policy is an issuer's commitment to make a fixed periodic dividend payment. This means investors can buy shares of a security with the confidence that they will receive a reliable distribution instead of a constantly changing payment.
How Does a Managed Distribution Policy Work?
Let's assume Company XYZ pays a quarterly dividend on its common stock. Although the board of directors can choose to pay a dividend in proportion to the profits for the quarter, the board might adopt a managed distribution policy. This way the firm pays $1.00 (or any amount it chooses) per quarter, per share no matter the amount of Company XYZ's profits.
Accordingly, if Company XYZ produces record profits in a quarter, the shareholders will still receive just $1.00 per share in dividends. Likewise, if profits do not meet expectations, shareholders do not face the prospect of receiving lower-than-expected dividends.
Many closed-end mutual funds, which distribute most of their income to shareholders in order to avoid taxation, adopt managed distribution policies. This often makes their share prices more stable.
One key drawback to managed distribution policies -- if the issuer generates sluggish profits, then it may not have the cash to make the distribution or dividend. For mutual funds, this is often alleviated by selling off some of the investment capital to raise funds. This has two effects: 1) part of the distribution is actually labeled a return of capital (and thus is generally not taxable) and 2) the fund is left with fewer investible assets with which to generate future returns.
This same notion applies to corporate dividend payers as well. For them, adhering to a managed distribution policy when cash flow isn't what was expected may require maintaining an increased cash position (and thus investing less in return-producing activities), borrowing money to pay the dividend, or selling assets to do so. In all three scenarios, this leaves a smaller asset base for the issuer to generate future income.
Why Does a Managed Distribution Policy Matter?
Managed distribution policies mitigate risks for both issuers and investors by reducing uncertainty. The issuers get a fixed, predetermined expense, and their share prices are often more stable. The investors get reliable income that is not so dependent on fickle quarterly performance. This arrangement is particularly attractive to income investors who depend on dividends to meet their living expenses or other cash flow needs.
It is important to note that the management of a mutual fund or the board of directors of a company can always decide to change or eliminate a managed distribution policy, especially during hard times. However, some boards are hesitant to do this, because the existence of the policy often lends support to the stock's price.
Some studies indicate that closed-end mutual funds with managed distribution policies trade at smaller discounts to their net asset values, and sometimes they even trade at a premium due to this policy. The important thing to remember is that although managed distribution policies may lead to predictable cash flows, they do not mean assured cash flows.