Distribution bonds are characterised by being invested in a diverse range of assets with higher yields and lower risk than pure equity funds. For this reason, distribution funds are often found within the Investment Management Association’s “Cautious Managed” sector. Sometimes they are referred to as “60/40” funds because of their respective asset allocation split between fixed interest and equities. As such, the term “distribution” can be used to describe an investment style as much as an investment product.
Often perceived as a less risky investment, suitable for more cautious investors, Distribution funds are often favoured by those seeking more transparency than the often opaque structure of with profit bonds, their closest peers. Distribution funds are particularly useful to those seeking a tax efficient, sustainable income. The yield from the underlying assets, or “distribution” can be paid out as income or you can chose to forego receiving it and have it re-invested back into the funds and additional units will be purchased. Alternatively, you can elect to receive either a defined percentage or fixed amounts of the invested amount as income.
If you require an income, care needs to be taken since different distribution funds distribute their income on different dates. These distributions tend to be quarterly or half yearly, depending on the fund you are invested in. If you choose to be paid the natural yield, or “derived” income from the funds, as opposed to the “defined” percentage of the original investment, you will not be entitled to receive any income until the next declaration date, irrespective of when you invested in the distribution fund. If you selected to take defined “income”, typically the 5% per annum withdrawals from your distribution bond, you will be asked to select the payment frequency of this income (ie monthly/ quarterly/ six monthly/ yearly). If you select monthly, dividend income from the funds will be moved into a lower risk fund, such as a cash fund where interest is added, from where it is paid out monthly.
Many distribution bonds allow you to convert the funds to unit linked funds should you wish to do so. It is also possible to invest in more than one distribution fund and to combine investing in distribution funds with unit linked funds held within the same investment bond.
Distribution funds are different to unit linked funds for four reasons:
- The way in which income is dealt with in the pricing of the fund. Between the dates when income is distributed, the unit price of the underlying funds will increase to reflect the income accrued but not distributed. The unit price will decrease again after the income has been paid out, or distributed.
- The asset allocation of a distribution funds tends to be more heavily concentrated in lower risk sectors such as gilts and corporate bonds. For this reason they are investments which tend to be favoured by more cautious investors. They cannot hold more than 60% of their assets in equities, must have a minimum of 50% invested in sterling based assets.
- They must yield at least 110% of the FTSE Allshare Index gross yield before charges are deducted.
- The fund must be capable of distribution.
The main providers of Distribution Bonds include Aviva, Legal & General, Prudential, Scottish Widows, Skandia and Standard Life. For more on the availability of Distribution Bonds, see our “Research & Buy” section.