When it comes to mutual funds, share splits are usually nothing more than a marketing device to encourage people to invest in the fund.
In the following article, we’ll explain how mutual fund splits work and how you should evaluate them.
Mutual Fund Split
A mutual fund split operates very much like a stock split, except it is far less common and has no impact on the fund’s value. A split occurs when a mutual fund boosts the number of shares outstanding while simultaneously lowering the price per share by the same magnitude. A mutual fund’s price is also called the net asset value (NAV) per share. This indicator represents the total value of the portfolio, less liabilities, divided by the number of shares outstanding.
Be sure to read about adjusted NAV here.
Like stock splits, mutual fund splits are expressed as a ratio, such as 2:1 or 4:1. In a 4:1 split, the number of shares outstanding is quadrupled and the price per share is reduced to a quarter of its value.
To illustrate, imagine that you own 100 shares of a mutual fund at a NAV price of $40 per share. After the fund undergoes a 4:1 split, you now own 400 shares at a NAV price of $10 per share. In both cases, the value of your shares is $4,000. To account for the cost basis after the split, you would need to increase your position by the split rate (i.e., 4:1) and maintain your original total cost and holding period. You would also need to decrease your per-share costs by the magnitude of the split.
The Rationale Behind a Mutual Fund Split
As we mentioned at the outset, a mutual fund split offers virtually no economic benefit to existing holders. However, the fund itself benefits from this strategy because share splits succeed in bringing a high net asset value back in line with the market average, which in turn helps boost sales.
This was confirmed by a well-known Wharton study, which showed that fund splits enhance the marketability of a mutual fund and succeed in bringing in new money.
In August 2018, Fidelity Investments announced share splits on 13 mutual funds by a magnitude of 10:1. As you can see by the following chart, the NAVs were lowered significantly as a result of the new policy.
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A lower NAV is theoretically more attractive to individual investors, but since share-splitting has no impact on future gains, any benefit that is derived from this policy is purely psychological. That said, share splits make sense for mutual funds whose NAV has appreciated significantly over the years. By introducing a share split, investors may have more flexibility to buy shares in full rather than at a fraction.
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The Bottom Line
Mutual fund shares have their time and place, but investors shouldn’t get too worked up over them. For the most part, share splits are used for operational and marketing purposes. Based on the results, fund managers that lower their NAV largely succeed in attracting new capital.
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