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U.S. stock indexes are hitting record highs while
Europe remains in a slump. That tells me that we’re in
for some significant capital gains distributions for
U.S. equity funds, but it might not be that bad elsewhere.
The trend is confirmed by data on mutual fund taxes.
Potential capital gains exposure has been on the rise.
Once a year, funds report how much unrealized
capital gains are in their portfolios. We then adjust that
figure each month for appreciation or depreciation.
The figure tells you approximately what the fund might
have to pay out as a capital gains distribution if it
sold every holding. Of course, it won’t sell everything,
so it’s quite rare for a fund’s actual capital gains
payout to equal its potential capital gains exposure.
In addition, we’ve had two mini-sell-offs this year
that could mean some funds realized losses to offset
gains or at least sold at less of a profit.
When
PCGE
rises, tax payouts rise. You can see that
from the graph, which shows that the tax-cost ratio
trend follows
PCGE
up and down. It makes perfect sense
that rising unrealized gains will lead to rising realized
gains. After all, most equity funds have turnover rates
greater than
50%
, implying that quite a few names
will be traded in the course of a year.
Today, the average equity fund has a
PCGE
of
11
.
2%
of
assets and a three-year tax-cost ratio of
1
.
92%
. Think of
that tax-cost ratio as an expense ratio for taxes. It
assumes that investors are in the highest tax bracket
and estimates how much per year investors paid out
in taxes as a percentage of returns. So, investors in
the top tax bracket who own funds in taxable
accounts paid out a big chunk of recent returns in taxes
because we are a long way into a market rally.
It’s a little worse than that for most investors. If I limit
my screen to funds with more than
$1
billion in assets—
because that reflects the funds most investors
own—the
PCGE
goes up to
19%
, although the three-
year tax-cost ratio is about the same.
You can find a fund’s tax-cost ratio in the FundInvestor
500
tab of mfi.morningstar.com. Slide the bar to the
right to see that column. To find a fund’s
PCGE
, click its
name and pull up the one-page report. The
PCGE
is
on the left-hand side of the report near the middle of
the page, just below the tax section.
Now, let’s add a third data point: flows. Many U.S.
equity funds have been hit with sizable outflows,
which means they have to sell off a good chunk of
their portfolios. This makes it much tougher for the
manager to keep the tax bill low.
I looked for funds with an unhappy convergence of
significant
PCGE
and outflows in order to flag some
funds likely to make a big payout. Typically, these
payouts come in December, but occasionally funds will
make them early in order to get them out of the way
and remove the incentive for investors to flee. Whether
you should actually sell to avoid the capital gains
payout depends on your cost basis. If you bought within
the past couple of years, you probably would do all
right by selling. However, if you’ve held for a decade or
more, you probably would end up with a big tax bill
either way, so ask your accountant. (Brokerages are now
required to track your cost basis but only from the
Funds Facing a
Tax Challenge
Fund Reports
4
Loomis Sayles Global Equity & Inc
Metropolitan West High Yield Bond
T. Rowe Price Real Estate
USAA World Growth
Morningstar Research
8
Do Objectives-Based Funds Deliver?
The Contrarian
10
Defensive Funds for Offensive Times
Red Flags
11
Funds That Lack the Protection
of Moats
Market Overview
12
Leaders & Laggards
13
Manager Changes and News
14
Portfolio Matters
16
7 Retirement Blindspots to
Watch Out For
Tracking Morningstar
18
Analyst Ratings
Income Strategist
20
Bank-Loan Funds Losing Appeal
Changes to the 500
22
FundInvestor 500 Spotlight
23
Follow Russ on Twitter
@RussKinnel
RusselKinnel, Director of
ManagerResearch and Editor
FundInvestor
August 2016
Vol. 24 No. 12
Research and recommendatio s for the s riou fund investo
SM
Continued on Page 2