The authors observed that a few funds actually advertise their juicing behavior. In 2010, Morningstar identified an illustrative list of seven funds that explicitly describe a juicing strategy in their prospectuses. The properties of these funds are sometimes quite astounding. The authors noted that in 2009, the First Trust Dividend and Income Fund (FAV) listed a ratio of income to assets of 19.3% and an annual turnover rate of more than 2,000%.
The authors found that juicing is a persistent, and thus predictive, behavior. Funds that juice in one year (i.e., have an excess dividend ratio outside what chance alone would predict) are much more likely to juice in other years. This is consistent with juicing being a deliberate behavior.
Not unexpectedly, the authors found that juicing is costly to investors through higher trading costs (commissions, bid/offer spreads and market impact costs). They found that funds with an excess dividend ratio above 1.38 have turnover 11% higher (with a t-stat of 4.2). Funds with an excess dividend ratio above 2 have turnover 17% higher (with a t-stat of 4.0). In addition, juicers incur increased taxes, ranging from 0.6% to 1.5% of fund assets per year. And this assumes that all dividends are qualified.
The implication is striking: “Investors who seek an income stream are better off creating it by selling fund shares than by investing in a fund that juices.”
Juicing Drives Inflows
Despite the many issues with juicing, Harris, Hartzmark and Solomon found that funds with an excess dividend ratio greater than 1.38 received on average an additional 6.8% of inflows a year when compared with other funds with similar observable characteristics. An excess dividend ratio greater than 2 is associated with an additional 12.2% of inflows a year.
Furthermore, the authors sought to identify who bought funds that engaged in this bad behavior. The hypothesis would be that juicing must appeal to less-sophisticated, uninformed investors. Consistent with this expectation, juicing is significantly less likely for funds with institutional share classes (institutions are considered to be more informed).
In addition, dividends should be more valuable to investors with lower income tax rates, or to those who pay no income tax at all. Yet juicing is more likely to occur among retail funds, whose investors have a greater likelihood of paying income taxes on dividends when compared with institutional funds (which are more likely to have tax-free investors such as retirement accounts or charitable institutions).
Perhaps not surprisingly, given the less-sophisticated nature of their buyers, the authors also found that juicing is more common among funds with higher expenses (which further serve as a drag on returns).
Finally, the authors noted their results are consistent with investors who psychologically distinguish between consuming income produced by their assets and consuming the capital value of their assets. This is simply a labeling error (or a framing problem), and thus leads to irrational behavior. Unscrupulous mutual funds, however, cater (or pander) to unsophisticated investors, charging higher fees and delivering lower returns with less tax efficiency.