149 / 772
3
Morningstar FundInvestor
April
2015
potential capital gains exposure. After a long streak
with no capital gains payouts, the fund dished out a
small
4%
distribution last year.
Higher-Turnover Funds
The list of funds with large potential capital gains
exposure has mostly very low-turnover funds, which
are less likely to make big payouts. However,
as you get above a turnover of
40%
in a fund with a
potential capital gains exposure above
40%
, it’s a
virtual certainty they will make a sizable distribution.
They’d have to have nearly all of the turnover just in
the holdings not held at a gain or all of their gains in a
small number of holdings in order to avoid a payout.
T. Rowe Price Health Sciences
PRHSX
has been
making money like nobody’s business thanks to
its biotech exposure. Thus, it’s probably not a surprise
that it paid out about
12%
of
NAV
in capital gains
last year. With a
47%
potential capital gains exposure
and a turnover rate of
42%
, I’d imagine those tax
bills will continue.
Morgan Stanley Institutional Growth
MSEGX
is
in a similar boat. It has strong returns, a
45%
potential
capital gains exposure, and
42%
turnover. The fund
paid out a modest
5%
gain last year.
Fidelity Contrafund
FCNTX
has seen a little less
in redemptions than the Fidelity funds mentioned
above. It has about
10%
in outflows, but manager Will
Danoff also trades a bit more with turnover of
45%
.
The fund paid out about
7%
in capital gains last year.
I should note that all three Fidelity funds mentioned
above are widely held in
401
(k)s and other tax-
sheltered accounts, so the managers have the difficult
position of trying to maximize returns equally for tax-
sheltered investors and those in taxable accounts. A
trade might be advantageous on a pretax basis but not
on an aftertax basis if the manager only expects
modest improvement by switching to a new position
from a current holding that has capital gains
embedded. Yet with that shareholder base, they might
be inclined to make the trade anyway.
T. Rowe Price Growth Stock
PRGFX
has a low turn-
over rate, but it has a new manager and potential
capital gains exposure of
45%
. The fund dished out
about
10%
of
NAV
in capital gains last year.
Big Potential Capital Gains Exposure Only
There are some funds that have big potential capital
gains exposure but low turnover, plus stable flows
and management. Even these funds will have to make
payouts sometime, but I am less worried.
Vanguard Primecap
VPMCX
is going great guns,
but that means it has a
78%
potential capital gains
exposure. The fund distributed about
5%
in gains in
2014
even though its latest turnover rate was just
11%
.
Gabelli Asset
GABAX
has a potential capital gains
exposure of
64%
but single-digit turnover.
Touchstone Sands Capital Select Growth
PTSGX
has a
30%
turnover ratio and a potential capital
gains exposure of
47%
. The fund distributed about
4%
of potential capital gains exposure last year.
What to Do About Capital Gains Payouts
If you own a great fund, then you’d be hurting yourself
if you sold it. But it might make sense to sell a medi-
ocre fund that is set to make big payouts. Also, if you
have automatic reinvesting for a taxable account that
might make a big payout, simply turn it off.
The next obvious thing to do is look closely at the
situation before buying in a taxable account. If
two funds are otherwise equally attractive but one
lacks the big tax overhang, go with that one.
Where to Find Tax-Efficient Funds
Index funds are a good bet. They rarely make payouts
and have low turnover. Vanguard is particularly good
at managing the tax situation of its index funds.
You can search for stock funds that have no or
low potential capital gains exposure. Today that
would mostly involve new funds or funds with
really bad track records, but don’t settle for an
inferior fund.
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