Distribution funds

Distribution funds are structured so that capital growth and income can be separated from each other. In most cases, a significant part of the portfolio is invested in fixed interest stocks (corporate bonds, gilts etc.) to provide the underlying income. The other main investment is in usually in income-bearing equities to provide further income and give capital growth potential.

The investment philosophy between a Distribution fund and a With Profits fund is fairly similar in that they each invest the majority of their fund in equities (usually between 40% - 60%) and fixed interest investments. Saying that, there are some major differences, which need to be recognised:

• The unit price of a distribution fund fluctuates as the value of the underlying investments fluctuate, whereas a With Profit fund will attempt to smooth out these underlying fluctuations. The result of this is that the workings of a distribution fund are more transparent than those of a With Profit fund. 
• The unit price of a With Profit fund will only move upwards and this is the result of the smoothing process. Whereas the unit price of a distribution fund can fall as well as rise as the underlying investments fall or rise.
• To compensate for the additional risk of a distribution fund (i.e. it can fall) there is additional growth potential if equities perform well, as these bonds will immediately benefit from the full equity growth in the fund.

Income withdrawals

Distribution funds are typically used by investors seeking income. However, as income can be reinvested, they can also be suitable for investors looking for growth on a total return basis. There are number of income withdrawal options availble to investors, these are:

• A percentage of the initial investment paid monthly, quarterly, half-annually or annually. Under this option all distributions are reinvested to purchase additional units and then regular withdrawals are made by cashing in units. By using this method the 5% rule can be utilised to maximise the tax deferral facility.
• A specific cash amount on a regular basis. This works very much along the same lines as the above option. It should be recognised that in adverse market conditions, both this option and the above option are likely to erode capital from the fund.
• The full distribution where investors take all distributed income, generally on a six-monthly basis. The withdrawals will vary depending on the size of distributions but should provide a rising income over the long-term, as the fund benefits from capital growth. In addition, these withdrawals are taken from the distributions and so units are not cashed in. 
• Deferred income (no withdrawals) where income is automatically reinvested and used to purchase additional units in the fund chosen. Generally an investor can choose to take an income at any time in the future.