Why an Income Fund’s Unit Price Can Rise Before Income is Paid
Many investors expect an income-focused fund to pay regular distributions while its unit price remains relatively stable. However, a fund’s unit price can rise when income has been earned but not yet been received or paid as cash.
For investors in certain Remara funds, this can occur where loans, particularly those funding construction and development projects, capitalise interest.
How Capitalised Interest Works
As projects, such as construction and development, are still being built, they typically do not generate cash flow that can be used to make regular interest payments. Instead, the interest is added to the outstanding loan balance over time, increasing the amount owed to the fund. The value created by the project is realised when the development is completed and sold, or when the loan is refinanced, at which point the accumulated interest is repaid alongside the original loan amount.
As the interest is earned, it is recognised in the value of the fund’s assets. Because unit prices are based on the fund’s net asset value, including accrued income, the unit price may gradually increase even though the cash has not yet been received.
Why Should the Unit Price Reflect Accrued Income?
Recognising accrued income helps ensure returns are allocated fairly between investors who are already invested in the fund and investors who join later.
A Simple Example
Assume a fund begins with a unit price of $1.00.
- The fund’s loans earn $0.05 per unit of capitalised interest.
- The underlying value of each unit increases to $1.05.
- If units were still issued at $1.00, a new investor could gain exposure to income earned before they invested.
With the unit price valued at $1.05, it helps avoid diluting existing investors’ interests and ensures new investors subscribe at a price that reflects the value accrued within the fund.
What Happens When the Loan is Repaid or Sold?
By the time a capitalising loan is repaid or sold, much of its accrued income may already be reflected in the unit price. When the fund receives the cash, it may distribute that income to investors.
After the distribution is paid, the unit price will typically fall by a similar amount because value has moved from the fund to investors. This is similar to a share trading ex-dividend.
A Useful Comparison With Shares
A company may earn profits before paying a dividend. Those retained profits can be reflected in its share price. When the dividend is paid, the share price typically falls by approximately the amount of the dividend.
An income fund can work in a similar way. Income that has been earned but not yet distributed is reflected in the unit price. Once that income is paid to investors, the unit price adjusts lower.
A rising unit price does not necessarily mean an income-focused fund is seeking capital growth. It may simply reflect income that has already been earned within the fund’s underlying loans. Recognising that income as it accrues helps allocate returns fairly between existing and new investors.
