(PUB) Investing 2015

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The downside to a seven-year bull market is
taxes. Even if you don’t sell your funds, you will be
getting more capital gains distributions, which
require you to pay taxes (unless your funds are in a
tax-sheltered account.)
We’ve seen the amount of capital gains steadily
creep up in recent years, and that figures to continue
as long as the stock market rally does.
Selected American Shares SLADX is a good
example. In 2009, the fund gained 32% but made no
capital gains payout because it had loss write-offs
from the bear market. It gained 12.9% in 2010 and lost
4% in 2011, again with no capital gains payout in
either year. But the stock market gained steam in 2012,
and the fund made its first payout in a decade at $2.25
per share—about 5% a share. Then in 2013, it paid
out $4.28 per share, or 10%, and in 2014, it paid out a
hefty $9.71—about 20% per share.
Not only did the fund burn through its charge-offs, but
it also suffered redemptions that spurred selling. Also,
comanager Ken Feinberg’s departure in early 2014
spurred management to clear out some of Feinberg’s
favorite picks. The fund and its Davis New York
Venture NYVTX sibling still have potential capital
gains exposure of 50% of assets under manage-
ment, so the payouts will probably keep coming.
Potential capital gains exposure tells you roughly how
much a fund would pay out if it turned over its entire
portfolio. It’s a useful measure in figuring out if a
fund is likely to make a distribution. Funds report the
figure once a year, and Morningstar then adjusts it
monthly to reflect appreciation or depreciation in the
fund. You can find a fund’s potential capital gains ex-
posure in our one-page reports o
The figure is located in the middle of the page, on the
left side just above the analyst’s byline.
I should note that all of this applies to stock funds only,
because bond funds’ returns come through chiefly
as income, and there are no capital gains if they hold
a bond to maturity. In addition, when funds replace
maturing bonds with new bonds, that counts as turn-
over, yet it wouldn’t spur capital gains distributions.
There’s a little more information we need to see,
though, before we issue a tax warning. First, I want to
see if a fund has sizable redemptions. Say a fund
sees 20% of its assets go out the door, that means it
probably has to sell about 20% of the portfolio,
unless it is sitting on a huge pile of cash. What’s
happening here is you have to go deeper into your pile
of stocks held at a gain, and you are spreading those
gains out over fewer and fewer shareholders. It’s a
little unusual to have redemptions in a fund that has
had sizable gains, yet that’s just what we are seeing
in a lot of equity funds these days.
I also want to know a fund’s turnover rate. Generally,
a fund won’t have huge, built-up capital gains if
it has a high turnover rate, but you will see some
with high potential capital gains exposure and a
turnover rate above 40%. In such cases, it’s a given
that you will see some distributions. Let’s first
Tax Bills on the Rise
for Fund Investors
Fund Reports 4
Janus High-Yield
Perkins Mid Cap Value
Vanguard Health Care
Vanguard Mid Cap Growth
Morningstar Research 8
Expense Ratios Are Falling
The Contrarian 10
Shelter From a Rising Dollar
Red Flags 11
Big Biotech Bets
Market Overview 12
Leaders & Laggards 13
Manager Changes and News 14
Portfolio Matters 16
GMO’s Ben Inker Sees Dark
Skies Ahead
Tracking Morningstar 18
Analyst Ratings
Income Strategist 20
Where Yield Is a Red Flag
FundInvestor 500 22
FundInvestor 500 Spotlight 23
Follow Russ on Twitter
@RussKinnel
RusselKinnel, Director of Fund
Research and Editor
FundInvestor
April 2015 Vol. 23 No. 8
Research and recommendatio s for the s riou fund investo
SM
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