11
Morningstar FundInvestor
July 2
014
Many stock funds in the Morningstar
500
are cur-
rently sitting on a substantial amount of capital
appreciation. More than
100
of them had a potential
capital gains exposure of
33%
or more at the end
of May—which means embedded capital apprecia-
tion accounts for at least a third of their asset
bases. That's not a bad thing, per se. Those gains
won't necessarily be realized and distributed to
shareholders. In fact, a high potential capital gains
exposure is generally a positive indicator that a
fund has both earned a nice return and been tax-effi-
cient in the process, usually by keeping turnover
low and sometimes by intentionally taking taxes into
account when trading.
Vanguard Tax-Managed
Capital Appreciation
VTCLX
, which aims to mini-
mize regular taxable distributions, has a potential
capital gains exposure of
49%
.
You wouldn't want to buy into a fund and then get hit
with a distribution of gains you weren't around to
enjoy, however. While a low-turnover fund isn't likely
to suddenly sell off a significant portion of its port-
folio, sometimes a manager's hand is forced in order
to raise cash to meet redemptions. And many stock
funds have been in steady net redemptions over the
past year.
Triple Threat
Westport Select Cap
WPSRX
might be a perfect
storm. It has potential capital gains exposure of
70%
,
the highest in the
500
. On top of that, shareholders
have been selling out; the fund has had nearly
$120
million in net outflows over the past
12
months, a
significant chunk of its asset base, which is now
below
$400
million. Finally, the fund had almost no
cash reserves as of the end of March.
The pent-up gains at
Royce Low-Priced Stock
RYLPX
aren't quite as high at
31%
, but it has seen
extraordinary outflows of
$1
.
4
billion over the past
12
months, more than its current total asset base of
$1
billion. It, too, has little cash on hand to meet future
redemptions. Similarly,
Wasatch Ultra Growth
WAMCX
, with a potential capital gains exposure of
45%
and almost no cash, has had net outflows of
nearly
$60
million over the past year, bringing assets
down around
$110
million.
These are extreme but not isolated examples. There
are several other funds with a particularly potent
combination of potential capital gains exposure
greater than
40%
, almost no cash, and significant
outflows over the past year that have persisted in
recent months. They include
Columbia Acorn
USA
AUSAX
,
Columbia Acorn Select
ACTWX
,
Ariel
ARGFX
,
Fidelity Growth Company
FDGRX
,
Royce
Premier
RYPRX
, and
Fidelity Small Cap
Value
FCPVX
.
Unlikely but Not Impossible
A fund with high potential capital gains exposure that
also has a low-turnover strategy and net inflows is
less likely to make significant distributions. Vanguard
Tax-Managed Capital Appreciation falls into that
camp, as do names such as
ClearBridge Aggres-
sive Growth
SHRAX
(with a potential capital gains
exposure of
64%
),
Baron Growth
BGRFX
(
58%
),
and
Sequoia
SEQUX
(
55%
). Those funds also have
some cash at the ready—particularly Sequoia, with
a
20%
stake.
A high cash stake is no guarantee that a fund won't
be selling stocks. As we reported last November,
cash-heavy
Longleaf Partners Small-Cap
LLSCX
distributed about
15%
of its net asset value in
2013
,
because its managers were selling holdings deemed
too pricey. While shareholders may have been
unpleasantly surprised, the move made sense given
Longleaf's pessimistic view of valuations. Unless
a strategy is specifically designed to minimize taxes,
sizable distributions are always a possibility.
œ
Contact Laura Lallos at
Watch Out for the Tax Bill on
These Funds
Red Flags
|
Laura Lallos
What is Red Flags?
Red Flags is designed to alert
you to funds’ hidden risks. Such
risks can take many forms,
including asset bloat, the depar-
ture of a solid manager, or a
focus on an overhyped asset
class. Not every fund featured in
Red Flags is a sell, and in fact,
some are good long-term hold-
ings. But investors should be
prepared for a potentially bum-
pier ride in the near future.
