I recently received this question from a reader:
Hi Financial Horse,
What is your take on Distribution Reinvestment Plan? I have the option to receive either cash or shares on Mapletree Logistics.
And today, this arrived on my mail:
The coincidence tickled me so much that I felt I had to do a short post on it.
Basics: What is DRP and why are they useful?
Very simply, a distribution reinvestment plan (DRP) allows you to choose between either receiving your distribution in cash or in units (shares).
To illustrate very simply, imagine you have 1000 units in Mapletree Logistics Trust, trading at S$1 each. You receive a distribution of 5%, which works out to S$50. You can choose to either receive S$50 in cash, or 50 units (which works out to S$50).
There are a lot of financial blogs and writers out there that will swear by distribution reinvestment plans. The most common reasons are:
- Transaction Fees – When you elect to get your distribution in the form of units, you don’t incur any additional transaction fee. This can be great because if you were to buy S$500 worth of units in Mapletree Logistics Trust, you’re actually incurring quite a hefty transaction fee as a percentage of your investment, and distribution reinvestment plans are a great way around this.
- Discount to trading price– To offer retail investors a bone (DRPs are primarily subscribed by retail investors), the units issued under a distribution reinvestment plan are almost always issued at a discount to the prevailing market price. The discount is small, typically 1 – 2 %, but hey, it’s better than nothing right?
- Autopilot your way to riches – The conventional argument is that distribution reinvestment allows compounding to really take effect. If your S$1000 worth of REITs pays you S$50 a year, and you use that S$50 to buy more REITs that gives you even more units, before you know it, you’ll be swimming in riches due to the power of compounding. Sounds a bit ridiculous when I say it like that, but you get the idea.
- Avoid spending the money – This one really depends on who you are as an investor. If your alternative is to take the distribution money and blow it all on an expensive meal, distribution reinvestment is really great because the money never hits your account, and you never have the opportunity to spend it.
Why I skip them
Here’s my take on distribution reinvestment, and why I’ve never signed up for them so far:
1. Odd Lots
I actually feel quite stupid putting this as the first reason, but it’s quite a big one for me. Distribution Reinvestment usually always results in you owning odd lots (ie. not ending with 100), which I absolutely detest. Odd lots are tricky to sell (you need to wait for an odd lot counter to open up, which only happens once in a while), which means that if you want to exit a REIT while holding odd lots, you’re going to be stuck with something like 34 units after you sell everything. That’s just ridiculous.
2. No control over price
Reason number 2 is trickier. Because the units under the distribution reinvestment plan are issued based on the price at a certain date, it creates a situation where you have to choose whether you want to get units or cash at a time when the unit price is higher or lower than the offered price.
A quick illustration using Mapletree Logistics:
|Advanced Distribution for the Period from 1 July 2018 to 27 September 2018||Date|
|Books Closure Date||27 September 2018
|Despatch of Notice of Election and Tax Declaration Forms||5 October 2018|
|Unitholders and depository agents must have completed and returned Form A or Form B, as applicable, and to receive new units under DRP, the Notice of Election to the Unit Registrar, Boardroom Corporate & Advisory Services Pte. Ltd.||18 October 2018
|Distribution payment date / Credit of DRP Units to Unitholders’ securities accounts||1 November 2018|
|Expected date for listing of DRP Units on the SGX-ST||1 November 2018|
Based on the form I got, I have the option to get my distribution in units, at the issue price of S$1.2061 for each new unit. The calculation of this price is based on:
The issue price represents a 2% discount to the adjusted volume-weighted average traded price per Unit (“DRP Adjusted VWAP”) for all trades on SGX-ST during the period of 10 Market Days prior to and ending on the Books Closure Date of 27 September 2018.
Basically, I need to decide by about 17 October 2018 (to buffer in some time for mail) whether I want to buy new units at S$1.2061. Based on today’s trading price (10 October 2018), Mapletree Logistics is trading at S$1.210 so it doesn’t really make sense, but if the current market price is much higher or lower, it becomes quite a simple decision.
The reason why I hate DRP, is that I hate having to run through this analysis every time I receive a distribution reinvestment form. It’s quite a nuanced decision deciding whether I want to subscribe for new units at the current price, and if you take a step back, it’s a lot of effort for something like 2% of your total investment in the REIT. For this reason, I always elect to take the cash, and when I build up sufficient cash, I’ll make the decision on which stock/REIT I want to add to.
3. REITs are an income play
Dividend Reinvestment Plans can make perfect sense for growth stocks, where you’re buying it for the capital appreciation, and you’d prefer that any dividend go into buying new stocks. REITs are more of an income play, where a majority of the returns comes from the distribution. By subscribing to a distribution reinvestment plan, I’ve always felt that it was like trying a REIT into a growth/capital appreciation stock, which is quite strange because it really isn’t.
The equivalent is like owning 20% of a property with your friend owning the rest, and you forgo your monthly rental every month to buy over some of your friend’s share. There’s technically nothing wrong with it, but it makes me wonder why you bought the property in the first place if it wasn’t for the rental income.
4. Hard to keep track of asset allocation
It’s another administrative reason, but I don’t like distribution reinvestments because if left unchecked, over time, it can skew the allocation of your portfolio towards REITs. Your REITs allocation will continually increase due to the reinvestment, whereas your stock portfolio may not increase at the same pace, and you’re eventually forced to rebalance.
I think it’s quite clear from this article that there’s really no right or wrong answer when it comes to distribution reinvestment plans. It’s really a personal preference. If you look at the statistics, distribution reinvestment is taken up primarily by retail investors (institutional investors always take the cash), so in some ways it is the REITs trying to throw us a bone. Personally though, I always take the cash, pool it up with my funds, and reinvest once I find a good buying opportunity.
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Talking abt transaction cost is penny wise but pound foolish to me because I usually invest a certain amt each time to optimise the transaction cost.
I agree and lean towards #1, 2 & 4 in your post. So each time I see the pink and blue letter, I tear and discard it immediately.
I had been living on passive income for a while now. So another no brainer.
Great comment. Agreed with you 🙂
DRP usually allow you to take a part in units and parts in cash. It’s a simple spreadsheet to work out how to avoid odd lots. If the price goes down then just take cash. Otherwise I always enjoy the discounted price. If you buy later, the transaction cost may be minimized, but it’s never going to be zero!
Good point. Thanks for the tip!