I think something gets lost in discussions about whether a fund’s distribution is “sustainable”: what do we actually consider a pretty damn good long-term return? ⠀ In my ERP post, I talked about using the risk-free rate plus the equity risk premium as a starting point for expected stock returns. The estimate I discussed came out around 9% nominal, before inflation. That isn’t a ceiling or a guarantee, but it gives us somewhere to start when thinking about what an investment might reasonably deliver. ⠀ https://www.blossomsocial.com/posts/Equity-Risk-Premium-9percent__POST-1788217798809-T6cHd7D9_t00uBlccemcq8jzT ⠀ Different exposures and strategies deserve different assumptions. If we expect substantially higher returns, though, there should be an explanation for where that additional return comes from and why it should persist. ⠀ Warren Buffett is an interesting reference point here. He’s widely regarded as the greatest investor of all time, and from 1965 through 2025, Berkshire compounded at 19.7% annually, compared with 10.5% for the S&P 500 with dividends included. Sustaining roughly 20% for that long is the kind of result that earned him that reputation. ⠀ https://www.berkshirehathaway.com/2025ar/2025ar.pdf ⠀ That gives some perspective on casually assuming 20%, 30%, or more as a long-term total return. ⠀ Those returns can obviously happen. They can happen for several years. But if we’re building long-term expectations around them, there needs to be something supporting that assumption. Maybe a manager adds alpha, meaning returns beyond what an appropriate benchmark or risk model would explain. Maybe leverage increases expected returns, or there’s some other advantage. ⠀ And even an established advantage doesn’t guarantee substantial alpha forever. Compounding the annual returns in Berkshire’s report over the 22 years from 2004 through 2025 gives approximately 10.5% annually, compared with 10.7% for the S&P 500 including dividends. That isn’t a formal calculation of alpha, but it shows how much closer Berkshire’s more recent returns have been to the market, despite its extraordinary lifetime record. ⠀ This connects back to competition. Sometimes when people say a fund manager needs to “stabilize the NAV and maintain the yield,” it sounds like the fund operates in a silo, where producing enough return is primarily a matter of choosing the right settings. ⠀ But there’s someone on the other side of each trade. Option buyers are paying for rights that have value. Other managers are looking for the same attractive opportunities. If an advantage is accessible and repeatable, more capital can pursue it and reduce the future reward. ⠀ That doesn’t impose a hard cap on anyone’s returns. It does make a large, persistent edge something we should explain rather than assume. ⠀ Which brings me back to high distributions. ⠀ In my High Yield post, I talked about why NAV erosion and distribution cuts aren’t inherently bad on their own. A fund could deliver a perfectly decent total return while its NAV declines because it distributes substantially more than it earns. ⠀ https://www.blossomsocial.com/posts/High-Yield__POST-1787186691972-RSs7aPx2_t00uBlccemcq8jzT ⠀ You can take that to an extreme mathematically. Start with $100 and distribute 99%, leaving $1. Then distribute 99% of that dollar, leaving one cent. You can keep taking a fraction of a positive balance indefinitely, even as the amounts become vanishingly small. ⠀ The NAV has almost completely disappeared, but you haven’t lost almost all your money. In this simplified example, you received it back as cash. Before costs and taxes, there was no investment gain or loss. ⠀ That’s why NAV erosion alone isn’t enough information. ⠀ This ties into @matt.41’s recent question about what a sustainable distribution would be for HHIS. Suppose, hypothetically, HHIS yielded 23%. The percentage alone doesn’t tell us whether the fund can maintain its dollar payments or support someone spending them while preserving their capital. ⠀ If we mean earning a 23% total return year after year, though, we’re expecting more than Buffett’s roughly 20% lifetime annualized return. That doesn’t make it impossible, but it brings us back to the question: what would allow the strategy to sustain a result that extraordinary? ⠀ Let’s set aside any negative opinions or “CC hate” you might encounter and focus just on total return and what we reasonably expect it to be. When someone like me questions whether a strategy is sustainable, that’s the concern: whether its expected total return can support the spending and capital preservation someone is counting on. ⠀ If a fund earns 9% but distributes 60% of its starting NAV, the difference has to come out of its NAV. A falling NAV or an eventual distribution cut can be exactly what we’d expect, even while the fund delivers a perfectly decent total return. ⠀ As I covered in “Separating the Variables: The Concrete Version,” reinvesting a percentage of the distributions isn’t enough information either. Spend half of a 10% distribution and you’re withdrawing 5% of the portfolio. Spend half of a 20% distribution and you’re withdrawing 10%. ⠀ Same reinvestment rule, twice the withdrawal rate. Whether either is sustainable still depends on the strategy’s total return and risk. ⠀ https://www.blossomsocial.com/posts/Separating-the-Variables-2-The-Concrete-Version__POST-1787842873351-Y6LX3ulN_t00uBlccemcq8jzT ⠀ There’s also a separate issue with “stable.” I wouldn’t treat XEQT as a stable place for a house down payment needed in the short term, and the same concern applies to income funds with meaningful stock-market exposure. Regular cash payments don’t make the capital supporting those payments stable. ⠀ Someone who understands these relationships may reasonably prefer a high-distribution structure. The concern I’m focusing on is the long-term expectation attached to it. We can disagree about what a strategy will earn, but that’s where the discussion needs to happen, because the distribution rate can’t answer that question for us. ⠀ It feels like every week we end up with another post about the discourse itself instead of the actual investing questions and trade-offs worth discussing. I hope this comes across as a respectful and useful breakdown for people who are curious. There’s plenty of room for different preferences, and I think understanding the assumptions behind them makes for a much more valuable conversation.
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17 Comments
le bib@le_bib · 1mo
23% would compound $100,000 into $3,127,919,531 in 50 years. Yes that's $3.1B or 3,100 millions. That's how absurd expecting 23% is
ETF Go
@etf.go · 1mo
What hopefully stands out to people is how few other people - including/especially those making sponsored videos about high fee high yield products- are discussing any of these topics. Instead many/most of them suggest you can ‘ignore returns’. You can’t. ‘Price doesn’t matter’. It does. ‘I never have to sell’. You just have to pay a high fee for the manager to sell and send distributions. ‘Allows me to focus on reinvesting’. But doesn’t show impact of longterm spending/withdrawals. There shouldn’t be any ‘CC hate’. The funds do what they are supposed to do. There is just disappointment in how people continue to spread one sided information while ignoring many of the factors (and risks) that actually matter. Great post as always! Hopefully it reaches the people who need it. 👏👍
Mr Financial
@mr.financial · 1mo
Really enjoyed this breakdown kar.... I especially liked the distinction between distribution and total return. Of course they don't mean the same. The Buffett comparison really puts those 20%+ return expectations into perspective. Great thought-provoking post as always! You are the Blossomer of deep thought that I just love.
Twenty-five And Invested
@25andinvested · 1mo
Im leaving a comment for the algos. I have nothing to add
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