In 2017, Hennessy Focus (HFCSX) paid out half a penny of capital gains per share on a net asset value of $87.76. In 2018, it paid out a huge $14.47 per share on a NAV of $67.71. This despite the fact that the fund returned 19.27% in 2016 and lost 10.47% in 2018. What happened?
Flows tell the story. The fund enjoyed inflows each year from 2013 through 2016, and even in 2017 they were a modest $148 million in outflows. But in 2018, outflows were $792 million from a base that started the year at $2.8 billion. For a fund whose asset base has bounced between $1.5 billion and $3 billion in recent years, that hit in 2018 was big. Inflows are a taxpayer’s friend because it means capital gains will be spread among more shareholders and the managers aren’t forced to sell anything they don’t want to. With outflows, though, a fund has to sell stocks unless they have a cash position larger than outflows. And after a long bull market, many stock funds are sitting on top of a big pile of profitable stock positions. The shift to passive from active means many are in outflows despite those gains. Once those profitable stock positions are sold, the fund makes a capital gains payout and fundholders get taxed. It’s a clumsy system because it doesn’t take into account fundholders’ actual gains in the fund.
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Russel Kinnel does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.