Juicing the Dividend Yield: Mutual Funds and the Demand for Dividends
- Harris, Hartzmark and Solomon
- A version of the paper can be found here.
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Some mutual funds purchase stocks before dividend payments to artificially increase their dividends, which we call "juicing." Funds paid more than twice the dividends implied by their holdings in 7.4% of fund-years examined. Juicing is associated with larger inflows, and is more common among funds with unsophisticated investors. This behavior is consistent with an underlying investor demand for dividends, but is hard to explain by taxes or need for income, as funds can generate equivalent tax-free distributions by returning capital. Juicing is costly to investors through higher turnover and increased taxes of 0.57% to 1.52% of fund assets per year.
Investors surely care about mutual fund returns, while some are also fond of steady and safe income flows, such as cash dividends from funds. This paper hypothesizes that fund managers will artificially increase dividend yields to attract investors, which can be called "Juicing Behavior." To be specific, managers would buy stocks shortly before ex-dividend dates, gather dividends and sell them afterwards.
This study targets three main questions:
- Does "Juicing Behavior" exist and how to exploit it?
- How "Juicing" behavior benefits managers?
- What are the costs to investors?
The paper highlights that dividend-paying fund managers' "juicing behavior" is aiming to increase dividend yields artificially. The paper measures the discrepancy between "implied dividends" and "actual dividends" to see whether such behavior exists in the mutual fund industry.
Without "juicing behavior", the total implied dividends from quarterly reports should be an unbiased estimate of total actual dividends. However, if the funds do engage in "juicing behavior", discrepancies would exist between implied and actual dividends.
- "Implied Dividends": dividends the fund would have received based on quarterly reported stock positions.
- "Actual Dividends": total dividends the fund actually received, based on the dividends distributed to shareholders and the fund's expenses.
To capture the discrepancy, the paper construct a metric named "Excess Dividend Ratio:"
Put simply, the higher the excess dividend ratio (>1), the higher the discrepancy between actual and implied dividends. If there is no "juicing behavior", this ratio should be approximate to 1.
1. "Juicing behavior" does exist.
The mean value of the "excess dividend ratio" is 1.17, which is greater than 1. So "juicing behavior" probably exists. What's more, in 7.4% of fund-years among dividend-paying funds, the excess dividend ratios are greater than 2--a large discrepancy.
Funds with an excess dividend ratio greater than 1.38 (the median 1% cutoff from the bootstrap analysis) hold stocks that are on average 4.1 days closer to the next dividend payment.
2. "Juicing behavior" attracts capital inflows --> Managers benefit!
The paper finds that funds with excess dividend ratio greater than 1.38 have a 6.8% more capital inflows per year than comparable non-juicing funds. When the excess dividend ratio is greater than 2, this extra capital inflows increases to 12.2% per year.
3. "Juicing" is costly to investors.
Trading in and out of stocks increases portfolio turnover, which leads to higher trading costs. Results show that juicing funds have 11% higher turnover than comparable non-juicing funds when the excess dividend ratio is above 1.38. When excess dividend ratio is above 2, the turnover of juicing funds is 17% higher!
"Juicing," historically, has been a tax-inefficient game to play, since dividend payments were taxed as ordinary income (this is less relevant today).
Last but not least, the paper finds that "Juicing" is more common among funds targeted at unsophisticated retail investors, who are less likely to catch "shady" activity such as "juicing."