(PUB) Investing 2015

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11 Morningstar FundInvestor November 2015
After a 6.5-year bull market, a fund’s long-term winners
can carry a bite. When funds sell stocks that have
appreciated, they have to make a taxable capital gains
distribution based on the total net value of realized
capital gains as of Oct. 31 of each year. (Russ Kinnel high-
lighted the growing problem of capital gains payouts
in the April issue of FundInvestor.)
Big fund companies typically come out with their first es-
timates for year-end distributions in early November.
This information is usually found within their websites,
by searching for taxes or distributions. They put out
final estimates a few weeks later, but the numbers rarely
differ. Payouts typically are made in the last week of
the year.
Some funds have already made their payouts. For
example, in early October, FPA US Value FPPFX, with
a Morningstar Analyst Rating of Neutral, issued a
massive $39.67-per-share capital gain amounting to 82%
of the fund’s pre-distribution net asset value. The
gain came after the fund got a new manager in June
2015 and he remodeled the portfolio’s mandate and
holdings. To FPA’s credit, it closed the fund when it an-
nounced the transition and warned investors about
the distribution.
Morningstar estimates a fund’s potential capital gains
exposure based on its net unrealized capital appreciation
and net realized gains included in the fund’s annual
report. We also factor in recent price appreciation, less
any capital gains distributions since the annual report.
The result is scaled by current assets to lead to a likely
payout figure that’s subject to taxes. Fund companies
usually begin posting capital gains distributions esti-
mates to their websites in early December. Here
we provide updates for several U.S. equity funds in
the Morningstar 500 based on September 2015 data.
Neutral-rated Buffalo Small Cap BUFSX has a potential
capital gains exposure of 75% of assets. Two portfolio
managers, Kent Gasaway and John Bichelmeyer, stepped
down from the fund this year, and outflows have cut
fund assets in half through the first nine months of 2015.
The fund issued a capital gain equivalent to 10% of
NAV in 2014.
Bronze-rated Dreyfus Appreciation DGAGX has suffered
$2.3 billion in outflows this year, amid lackluster
performance, cutting the fund’s asset base in half. The
fund distributed a small capital gain in 2014, but
imbedded gains still represent about 74% of the fund’s
NAV. The fund likely trimmed many appreciated
stocks to meet outflows, making a larger distribution
likely this year.
Another fund that’s been wracked by outflows is
Neutral-rated Columbia Acorn ACRNX. The fund has
underperformed and went through several manager
changes this year. Through the first nine months of the
year, investors redeemed a net $6.5 billion, leaving
the fund with just under $10 billion in assets. Remaining
investors face a potential capital gains exposure of
73%. The fund issued a capital gains distribution in June
2015 equivalent to 5% of the fund’s NAV , but more
may be on the way.
Kalmar Growth-with-Value Small Cap KGSCX has
lagged the Russell 2000 Growth Index by 5 percentage
points during the past three years. Investors seem to
have grown impatient, and the fund has been crushed
by outflows this year, cutting assets in half. With
potential capital gains exposure of 39%, the fund may be
unable to avoid issuing a capital gains distribution,
as it did in 2014.
It is usually not a good idea to sell a great fund in an
attempt to avoid a capital gains distribution, as you
will trigger your own capital gain. But it makes sense
to delay the purchase of a fund that is about to
make a distribution or to make the purchase in a tax-
sheltered account. K
Contact Michael Rawson at
Tax Season Is Getting Tough
Red Flags | Michael Rawson
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
departure 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
holdings. But investors should
be prepared for a potentially
bumpier ride in the near future.