Clarification Needed on PRPFX Yield

[KevD]

A question I've asked before is why is the yield on PRPFX so low.

The answer seemed to be that they reinvest dividends at their end, so we don't see them. 

To get a little official clarification, I looked in the prospectus. 

Dividends and Tax Planning

Each Portfolio distributes its net investment income and net capital gains, if any, to its shareholders as dividends only once a year and intends to continue to satisfy the distribution requirements necessary to qualify for treatment as a RIC.  Under the Code, a Portfolio is required to pay as dividends for each taxable year at least 90% of its investment company taxable income (which generally consists of net investment income, net short-term gain, and net gains and losses from foreign currency transactions) to qualify for such treatment.  Each Portfolio treats as dividends paid the proportionate amount of its investment company taxable income and net capital gain that is distributed in the form of redemption proceeds.  By using this permitted method of calculating dividends paid, each Portfolio is able to reduce the amount of such income that is distributed as dividends to shareholders who have not redeemed their shares.

Each Portfolio has incurred and will likely continue to incur a federal excise tax of 4% on the part of its undistributed net income and capital gains, if any, that exceeds 2% of the sum of such income and gains for the taxable year.  This tax reduces the benefit of not distributing all of a Portfolio’s net investment income and realized gains.  See "Dividends, Other Distributions and Taxes." Such undistributed amounts are retained by the Portfolio and reinvested to earn further income and gains.  To the extent that a Portfolio successfully executes its policy, the tax liability of a long-term shareholder may be lessened (to an extent that the Fund cannot predict), without reducing the shareholder’s total return (dividends plus appreciation).

The language is a little over my head.  Can someone boil this down and explain in lay terms what happens to the dividends that we should be receiving on long-term bonds?  And is there a way to calculate what the actual yield would be if PRPFX was handled as a normal fund?  Hope I'm not asking for the impossible.    Thanks.

[MediumTex]

The dividends are held inside the fund to the extent the fund manager is able to do so.

This allows what would otherwise be ordinary income to be treated as capital gain instead and only be recognized upon sale of shares.

As far as what the yield would be, I don't know.

This aspect of the way the fund is managed is, to me, one of its strongest features for a taxable investor.

I don't understand how exactly they are able to pull this off.

In the past, PRPFX has had much larger distributions (I don't if it was because of fund redemptions or some other reason).

[KevD]

Thanks MediumTex.

That's plain English I can understand.

[LifestyleFreedom]

A mutual fund (which is a registered investment company in legal terms - http://en.wikipedia.org/wiki/Investment ... ct_of_1940) is not taxed at its level.  Instead, it has to pass on at least 90% of its interest, dividend, and capital gain income each year to its shareholders, who are taxed on this distribution.  Apparently, a mutual fund has to pay a federal excise tax if it fails to pay out enough of its income.

Whenever I've bought mutual funds over the years, I've had the option of either taking these distributions in cash, or having them reinvested in more shares of the fund.  I've always chosen the reinvestment route, but I still have to pay the income taxes anyway even if I haven't actually received the cash.

The presence of "unrealized capital gains" in an existing fund when you buy it make for some interesting dynamics.  Let's say the fund bought gold when it was at $200 an ounce, and then sold some of it years later to rebalance its portfolio when gold was at $1,200 an ounce.  That's a capital gain of $1,000 that the mutual fund realized.  But you bought your shares when gold was $1,100 an ounce and the price you paid for your shares reflected this value of the gold (because the fund is open ended, so its share price reflects the market price of its underlying assets at the end of every day).

Your taxes are based on a capital gain distribution of $1,000 (which is what the mutual fund realized) rather than the $100 (that you really experienced).  If you feel you got shafted, you're right, but it's how all mutual funds work.  It's just something to be aware of when you invest in "pass-through entities" such as mutual funds.

P.S., A mutual fund can be sitting on a large amount of unrealized capital gains.  Then many shareholders decide to redeem their shares, which forces the mutual fund to sell some of its assets to raise the necessary cash.  To the extent this selling involves appreciated assets, these capital gains become realized.  You still hold your shares at the end of the year, so you get to pay capital gains taxes as a result of these redemptions.  It's an example of how the "unsophisticated investors" (i.e., the redeemers) can shaft the "sophisticated investors" (i.e., you) because of the way tax law works.