Brace Yourself for Another Nasty Capital Gains Season
The strong equity market, active fund outflows are a bad convergence for taxable mutual fund investors.
Editor's note: This article has been updated with the latest information, including data for Vanguard and T.Rowe Price.
What's not to love about a rising stock market? Big tax bills for some mutual fund shareholders, that's what.
Mutual fund firms have begun publishing their estimated capital gains distributions in recent weeks. While it's too early to conclude that 2017 will be a particularly bad year from the standpoint of outsize distributions, the same factors that led funds to make big distributions in 2016 are in place again this year.
For starters, the equity market been on an extended tear, with the S&P 500 gaining more than 15% for the year to date through late October. If investors were steadily shoveling money into funds even as their holdings appreciated, that might not be such a big deal. But many active funds have actually been contending with asset outflows over the past few years: For the trailing one-year period through September 2017, investors had pulled nearly $240 billion from active U.S. equity funds. That's on pace with their redemptions over the same time frame a year ago.
The net effect of the asset outflows in a rising market is that active fund managers have to sell appreciated positions to meet investor withdrawals, and that action triggers capital gains distributions. In fact, the very category that has seen the biggest redemptions over the past year--large growth--has posted the highest returns of any diversified domestic-equity category so far in 2017.
Mutual Fund Capital Gains, Unpacked
If investors hold a fund that's making a big distribution in a taxable account, they'll owe taxes on the distributed gains unless they can sell losing positions to offset the gains. (Like mutual fund managers, however, most investors don't have a lot of losing holdings in their portfolios at this point.) And they'll owe taxes regardless of whether they spent the distribution or reinvested it.
On the plus side, investors in tax-sheltered accounts don't have to worry about their funds' capital gains distributions; they'll only owe taxes when they themselves begin selling their holdings. (Qualified withdrawals from Roth IRAs aren’t taxed at all.) It's also worth noting that reinvested capital gains help increase the investor's cost basis; that has the potential to lessen the amount of capital gains taxes due when the position is eventually sold. Investors who hold a serial capital-gains distributing fund in their portfolios may find that, owing to the step-ups in cost basis they've received in years past, selling the tax-unfriendly fund may cost them less than they would expect. This article discusses the topic in greater detail.
Here's a review of where some of the larger shops stand with respect to capital gains estimates so far. (Clicking on the fund company names below will take you to each fund company's own estimates.) For shops where information wasn't yet available as of our publication date, we'll link to and provide information about their estimates as they become available.
As in years past, American Funds deserves plaudits for publishing its capital gains estimates as a percentage of its net asset values; that makes it easy to discern whether a distribution is significant. As of mid-September, the firm's New Economy (ANEFX) fund was on track to make the largest long-term capital gains distribution, in percentage terms, in the lineup; the Gold-rated large-growth fund's estimated distribution amounts to 8% to 10% of its net asset value. Several of the firm's other domestic-stock funds, including Fundamental Investors (ANCFX), New Perspective (ANWPX), Growth Fund of America (AGTHX), and Investment Company of America (AIVSX), were on track to pay out between 5% and 7% of their NAVs.
As of Sept. 30, a handful of AMG funds were estimating total capital gains distributions in excess of 10% of NAV. AMG Frontier Small Cap Growth (MSSCX), for example, was anticipating a total distribution of more than 20% of its net asset value. Yacktman Focused (YAFFX) was estimating a total distribution of nearly 10% of its NAV, while Yacktman (YACKX) was expecting to pay out 7% of NAV. AMG TimesSquare Mid Cap Growth (TMDPX) was anticipating a 12% distribution, while Managers Montag & Caldwell Growth (MCGFX) was anticipating a 10% distribution of NAV.
The Columbia Acorn funds have been serial distributors of large capital gains, and 2017 is shaping up as no exception. The funds have seen a series of manager changes in recent years, accompanied by declines in their asset bases. Columbia Acorn (LACAX) is anticipating a distribution amounting to between 17% and 21% of NAV, while Columbia Acorn USA (LAUAX) is expecting to make a payout in the 22% to 27% range.
Dodge & Cox
As of Oct. 26, Dodge & Cox hadn't yet published capital gains distribution estimates for its mutual fund lineup. We'll link to the estimates when they become available.
Across Fidelity's large lineup, several funds are anticipating meaningful capital gains distribution. That's probably not surprising when you consider that many of the firm's largest funds lean toward the growth side of the style box, and such stocks have performed best during the current rally. Moreover, Fidelity's active-fund lineup hasn't been immune to investors' ongoing preference for passive products. Indeed, Fidelity's 500 Index fund (FUSVX) is now bigger than Fidelity Contrafund (FCNTX) and stands as the firm's largest offering. Redemptions can force funds to sell appreciated positions, which in turn can trigger capital gains distributions.
Among the growth-oriented funds expecting sizable distributions are Fidelity Capital Appreciation (FDCAX), which is anticipating a total distribution (dividends plus capital gains) that amounts to 8.5% of its Sept. 30 net asset value, Fidelity Independence (FDFFX) (11.2% of its September-end NAV), New Millennium (FMILX) (6.7% of NAV) and Fidelity Focused Stock (FTQGX) (7.6% of NAV). Stock Selector Small Cap (FDSCX) is expecting to distribute 8.4% of its NAV. Two of the firm's largest growth funds, Contrafund and Fidelity Growth Company (FDGRX), have managed to keep a lid on their capital gains distributions despite having blockbuster years in 2017; Contra's expected payout amounts to about 5% of its NAV, whereas Growth Company's expected distribution is an even lower 4.1%.
Not all of the big distributions are coming from the growth side of the house. Fidelity Dividend Growth (FDGFX), a large-blend fund, is anticipating a total payout amounting to 9.2% of NAV. Meanwhile, Fidelity Mid Cap Value (FSMVX) is anticipating a distribution of 8.6% of NAV; Value Strategies (FSLSX) is expecting a 7.6% payout. All three are in the midst of management changes, which can often lead to portfolio changes and in turn capital-gain distributions. Fidelity Low-Priced Stock (FLPSX), the firm's most prominent value fund, is expecting to make just a tiny distribution this year.
Many of the very large funds under the Franklin Templeton umbrella are income-centric, so they pay out most of their distributions in the form of income, and capital gains aren't meaningful. Yet a few of the firm's large funds are anticipating sizable capital gains distributions in December. Franklin Small Cap Value (FRVLX) is expecting to pay out a distribution between 7% and 13% of its September-end NAV, while Franklin Small-Mid Cap Growth (FRSGX) has an estimated payout amounting to between 6% and 11% of September-end NAV. Templeton World's (TEMWX) estimated distribution is between 3% and 8% of its net asset value at the end of September. Franklin Real Estate Securities (FREEX) is anticipating a distribution of between 7% and 9% of NAV, while Franklin Convertible Securities (FISCX) is expecting a 5% to 10% payout. Among smaller funds expecting distributions in the 5% to 10% of NAV range are Franklin Balance Sheet Investment (FRBSX) and MicroCap Value (FRMCX). Franklin Mid Cap Value (FMVAX) is expecting to distribute 4% to 10% of its September-end NAV, while Templeton China World's (TCWAX) expected distribution is 7% to 12% of its September-end NAV.
As of early September, Janus Henderson Mid Cap Value (JMCVX) was anticipating a total payout of 9% of its NAV. Janus Henderson Contrarian (JSVAX) and Janus Henderson Forty (JACTX), meanwhile, were forecasting total distributions of 7% and 8%, respectively.
As of Sept. 30, Longleaf Partners (LLPFX) and Longleaf Partners Small-Cap (LLSCX) were both anticipating distributions amounting to 6% of NAV. If CenturyLink (CTL) completes its acquisition of Level 3 Communications (LVLT)--the top position in both funds--by the end of October, however, their distributions will be in the 9%-10% range.
JPMorgan Large Cap Growth (OLGAX) is anticipating a distribution in the neighborhood of 14% of NAV. The firm's US Large Cap Core Plus (JLCAX), meanwhile, expects a distribution of roughly 12% of NAV. After two straight years of sizable distributions, the firm's Equity Index (OGEAX) fund has managed to hold down its 2017 payout--it's anticipating a distribution of less than 1.5% of assets. However, the firm's Tax Aware Equity (JPEAX) fund is anticipating a payout of nearly 9% of NAV, despite the fact that it "seeks to minimize shareholders’ tax liability by limiting capital gains distributions."
As of Oct. 26, Morgan Stanley hadn't yet published capital gains distribution estimates for its mutual fund lineup. We'll link to the estimates when they become available.
As of Oct. 26, Oakmark hadn't yet published capital gains distribution estimates for its mutual fund lineup. We'll link to the estimates when they become available.
As of Sept. 30, none of the Primecap Odyssey funds was anticipating a sizable capital gains distribution for the year.
T. Rowe Price
Several T. Rowe Price funds are making sizable distributions. Leading the way are three growth-oriented funds-- Growth Stock (PRGFX), New America Growth (PRWAX), and Science & Technology (PRSCX)--all of which are estimating payouts that amount to 11% of their late-October NAVs. Several other funds are anticipating distributions in the range of 6% to 8% of their NAVs, including Equity Income (PRFDX), Mid-Cap Growth (RPMGX), Small-Cap Stock (OTCFX), Health Sciences (PRHSX), and New Horizons (PRNHX). The firm has seen a fair amount of managerial turnover in recent years, which has likely contributed to heightened turnover at many of these funds.
A handful of Vanguard funds will be making sizable capital gains distributions in mid-December. Vanguard Explorer (VEXPX) will be dishing out one of the largest at the shop; its distribution estimate amounts to more than 11% of its net asset value. The Bronze-rated fund has produced middling returns relative to its small-growth peers in recent years. (Its returns have been strong in absolute terms, however.) Vanguard Selected Value (VASVX), a midvalue offering, is also expecting a reasonably large payout--an estimated 9% of NAV; Morningstar downgraded the fund from Gold to Silver this year because of its heightened risk profile. Vanguard Morgan Growth (VMRGX), meanwhile, is estimating a capital gains payout that amounts to 7% of its NAV. Vanguard Windsor II (VWNFX) is also on the list of funds making meaningful payouts, with an estimated distribution that is just over 6% of NAV. Vanguard Primecap (VPMCX) is anticipating a distribution of roughly 4.5% of NAV, while Capital Opportunity (VHCOX), managed by the same team, expects to pay out roughly 4% of NAV. ( Vanguard Primecap Core’s (VPCCX) distribution is negligible). Two quantitatively managed funds, Strategic Equity (VSEQX) and Strategic Small Cap Equity (VSTCX) are expecting distributions of 7% and 6%, respectively.
Christine Benz has a position in the following securities mentioned above: OTCFX, VPCCX. Find out about Morningstar’s editorial policies.