Long-Term Winners with a Lid on Taxes
Despite their recent run-ups, these funds still offer a big break on taxes.
Even through we're eight months into a broad market rally, many fund companies expect that capital gains distributions will be limited this year. That's because funds have been able to use last year's steep losses to offset gains generated during the recent run-up. For a picture of where the 25 largest funds sit on the capital gains front, check out my colleague Courtney Goethals Dobrow's recent article.
While investors don't need to fret too much over distributions this year, the Premium Fund Screener can pull up some long-term winners with deeply negative potential capital gains exposures, which could enable them to offset taxable gains over longer periods. (Potential capital gains exposure estimates the percentage of a fund's holdings that represent gains and is calculated on a monthly basis by Morningstar.) To start, set the screener to pull funds with top-third 10-year category rankings and manager tenures of at least 10 years. The next step is to set the funds' potential capital gains exposure to negative 40 % or less. It's also helpful to limit the results to offerings that don't trade excessively, as this can generate taxable distributions. To do this, set the screen to pull funds with below-average turnover relative to their categories. Other key criteria include limiting the results to options available to new investors and investment minimums of $25,000 or less.
To run the screen yourself, click here.
Although the following funds are looking great this year, their painful losses in 2008 mean that it will still be quite a while before investors see a capital gains distribution.
Buying companies under a cloud contributed to Chesapeake Core Growth's (CHCGX) roughly 50% loss last year, as well as its current potential capital gains exposure of negative 48%. Investors need to be patient to do well here, but the veteran team and consistent process argue in the fund's favor. Managers Whit Gardner and John Lewis buy unloved stocks that they believe will beat Wall Street's estimates, but these stocks can fall hard over shorter time periods. For example, the managers held on to medicare benefit provider Humana (HUM) despite its sharp drop in 2008 on concerns that the government would cut the firm's services. That stock hasn't bounced back yet, but their stock-picking prowess is proven over the long haul.
Similarly, Polaris Global Value (PGVFX) sports an ugly three- and five-year record due to last year's 46% loss, but it boasts strong long-term fundamentals. Manager Bernard Horn Jr. has run this world-stock offering since its 1998 inception and has shown that a patient and contrarian process can win over longer time periods. The fund's recent stake in British homebuilders--which struggled mightily in 2008 only to come roaring back in 2009--is a case in point. And because the fund's potential capital gains exposure is negative 82%, it has plenty of losses on the books to offset future taxable gains.
Despite Wasatch Small Cap Value's (WMCVX) 41% gain for the year to date through Oct. 30, 2009, this small-blend fund is still sitting on a negative 54% potential capital gains exposure. The fund's 48% drop in 2008 landed it in the small-blend category basement for the year. Manager Jim Larkins' roughly 20% stake in energy firms contributed to its sharp drop, but his decision to add to beaten-up auto firms, such as O'Reilly Automotive (ORLY) and Copart (CPRT), during the worst of the sell-off helped it charge back during the rally. Overall, we like Larkins' approach, which focuses on "fallen angels," or former growth stocks that have stumbled, as well as "hidden gems," which aren't widely covered on Wall Street. And though the fund's name implies a value bias, Larkins' focus on earnings growth means he traffics in pricier names compared with most value offerings.
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Karin Anderson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.