Generating cash flow in a low yield environment

T-Series Funds allow investors to generate cash flow without sacrificing quality

With interest rates expected to remain at or near the current levels, many investors looking to generate income for their portfolios are once again in a very difficult position. Traditional safe haven investments such as GICs and other fixed income products are offering very little in the way of yield. This means that investors will have to take on additional risk to generate the income they need.

Fortunately, there are many options available that will allow investors to build a very high quality portfolio that has the potential to spin off decent cash flow without sacrificing investment quality. One of the ways to do this is to use what are known as T-Series Funds.

T-Series funds are an interesting animal in that they pay out regular monthly distributions that are generally treated as return of capital for tax purposes. What this does is provide cash flow now, while pushing the tax liability down the road. This happens because return of capital distributions are not taxed immediately, but instead reduce the adjusted cost base (ACB) of the funds. When the investor sells the fund, the adjusted cost base would be considerably lower than had they not received the distributions, meaning they are paying capital gains tax on a much greater amount.

The distributions that T-Series funds pay typically will be in the 5% to 8% range, however most of the funds tend to offer the 8% payouts. Some companies such as CI and Dynamic will even allow investors to set the payout they wish by specifying a set percentage or dollar amount. Many companies offer these funds, covering a wide range of asset classes, which allows considerable flexibility when building an overall portfolio that can be used to generate cash flow. In other words, investors don’t have to sacrifice investment quality or take on significant risk to generate a decent cash flow.

There are some drawbacks to these funds. The first is that while there are a number of options available, the majority of the funds available are equity and balanced funds. There are very few pure fixed income options available in the T-Series. Another drawback is that if the distribution payout is lower than the fund’s return, there will be erosion in the invested capital base. An 8% return is pretty optimistic for most investments, so some capital erosion is likely. A third drawback is that the distributions are typically reset on an annual basis. If there is there is a significant drop in the market in a year, the dollar value of the distribution is likely to be reduced. For example, if the price of a fund is $100 with an 8% payout, the annual distribution payout will be $8.00. However, if markets fall by 20% and the price is now $80, the distributions will likely be reset with to an annual payout of $6.40. In both cases though, the yield remains 8%.

A final drawback is that it is possible for the ACB of the fund to be reduced to $0 over time. Once this occurs, the distributions will be treated as capital gains for tax purposes.

As mentioned above, there are a wide range of T-Series funds that are available to investors. In fact, many of the funds that are on our Recommended List of Funds are available in T-Series. As a helpful guide, the following chart highlights our recommended funds that are available in T-Series, including fund codes for the front-end versions. The number after the T often refers to that expected annualized yield. For example, a T-5 fund will typically have an annualized yield that is in the 5% range, while T-8 funds will have a yield in the 8% range.

Source: Fundata

Bottom Line: T-Series funds can be a good way to generate regular, tax deferred cash flow from an investment portfolio. There are enough options available today that a strong, high yielding portfolio can be created without sacrificing on the investment quality. While they are not for everybody and do have some drawbacks, for investors looking to build a well diversified portfolio, T-Series funds are definitely worthy of consideration.