Here's Why You Don't Always Need an Income Share Class

And, does it matter whether the underlying goal of a fund is income generation too?

Kate Lin 24 October, 2023 | 8:00
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Kate Lin: Welcome to Morningstar. Investors are always excited about getting income, whether it is income from equity through dividends or income from bond yields. But when you select a fund, how does an income share class affect your dividend-hunting objectives? Today we're joined by Sam Hui, a manager research analyst at Morningstar, to talk about this topic.

Hi Sam. First, could you explain what an income share class is and whether investors always require this share class?

Sam Hui: Hi Kate.There aretwo broad types of share class investors can choose from when they invest in a fund – the income share class or the accumulation share class.

The income share class provides cash payouts to investors, typically out of the stock dividends or bond interests received from the portfolio or you may also be paid out of capital. The accumulation share class re-invests the income back into the fund to grow the investment value further.

Depending on your investment goals, you may choose either type. For example, a retiree who relies on the income generated by the fund for living expenses may find the income share class more suitable. But if you are not in need of the cash, the accumulation share class provides the benefits of compounding, which may enhance future total returns.

Lin: Well. Sam, you've touched on the decision between share classes based on an investor's investment goal. And, the next thing is: does it matter if the fund’s underlying goal is income generation?

Hui: So, a fund’s investment approach will influence the amount of income that it can generate. For example, an equity fund that focuses on dividend-paying stock is likely to be able to generate more income than an otherwise fund that focuses on growthy companies. This will in turn impact how much the fund can distribute to investors.

In general, funds that focus on income-generating assets may better align with investors who seek a stable stream for cash payout. These investors typically will choose the income share class.

For investors who want exposure to income-generating assets but do not rely on the cash payout, the accumulation share class may be a better fit. So we first choose a fund and then we decide on the share class.

Lin: In the market, some funds claim to offer an attractive payout. And how can investors keep a wary eye on these claims? Perhaps you can give us an example.

Understand What Is Backing the Yield

Hui: That's a great question. Everything comes at a cost and there is no free lunch for yield. We have to understand what is backing the attractive yield. Is the fund investing in risky assets that generate a larger amount of income, such as China high yield property bonds or is it depending on selling underlying assets to meet the high cash payouts? These strategies may work well in an up market, but they may also suffer a greater loss during an extreme market downturn as we observed in 2022.

Bear in mind that the payout yield does not equal the total returns we will get. We should look beyond payout yield and carefully review the fund’s prospectus, investment strategy, and historical performance and understand the underlying risk before we buy the fund. Make sure it is something we are comfortable with to put our money in over the investment horizon.

Lin: Wonderful. Thank you so much for your insights, Sam. For Morningstar, I'm Kate Lin.

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Kate Lin

Kate Lin  is an Editor for Morningstar Asia, and is based in Hong Kong

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