Collective investment schemes (CIS) set equalisation policy at incorporation. The objective behind setting an equalisation rate is to share the yield equally among investors, whether they joined at the beginning of the scheme or part way through. Equalisation is a rate earned by the fund up to a particular distribution date, representing the total income earned per share for that period.
This is one of the most important tools for investment decisions by those who join the scheme part way through the reporting period. It is also important for determination of tax liability. Equalisation reporting periods are set by fund managers and it could vary from monthly, quarterly, semi-annually or annually.
The rate is separately shown on the tax voucher which is issued to investors, and applicability of the rate can be checked through scheme documentation.
If an equalisation policy applies to a fund, then incoming investors pay the equalisation amount as an add-in on the price, and receive this money back when the fund distributes at the next distribution period.
What if there is no equalisation policy?
If there is no equalisation policy the income represents only capital asset appreciation or depreciation. This is then divided between the existing investors. Any investors who leave before the dividend distribution date would lose an opportunity to share appreciation, and would also leave a higher proportion of income to existing investors because there’s no equalisation policy.
For example, in the following case the income appreciation is 17% in 2015
|
2015
|
2016
|
Change
|
|
Total income to distribute
|
£3,89,000
|
£4,56,000
|
17%
|
|
Total number of shares
|
4,85,00,000
|
2,85,00,000
|
-41%
|
|
Dividend per share
|
0.0080
|
0.0160
|
99%
|
In the above example, the 99% dividend increase per share is misleading, because 41% of investors left before the dividend distribution date, leaving an impression that the fund performed exceptionally well. Had there been no decrease of investors by 41%, the income would have increased by only 17%.
Expanding on this example, if the number of shares were to reduce by 21%, then the increase in distribution per share would be 48%.
|
2015
|
2016
|
Change
|
|
Total Income to distribute
|
£3,89,000
|
£4,56,000
|
17%
|
|
Total number of shares
|
4,85,00,000
|
3,85,00,000
|
-21%
|
|
Dividend per share
|
0.0080
|
0.0118
|
48%
|
So, in a fund with no equalisation policy, investors should keep an eye not just on fund performance but on how other investors are thinking. If they stay while others are leaving and the fund starts overperforming, they would enjoy a higher share.