When we do income tax planning for our clients one of the most frustrating aspects is YE mutual fund distributions.

Each year mutual funds distribute to shareholders a pro rata portion of net realized gains and interest/dividends.  Early each year the best we can provide our clients with is a guesstimate based upon a fund’s trading activity / portfolio turnover, overall market directions (big price increases/decreases) and historical distributions.  As such we often overestimate gains to be conservative.  Our view is it’s better to have a positive surprise come tax time than a negative one.

At the request of some of our more detail-oriented clients we have curtailed our overestimation of gains.  Get ready folks because your day of reckoning is coming.

Five years into the stock market’s post-financial-crash rally actively managed equity mutual funds are expected to distribute capital gains at a far greater rate than any time since 2008.  Why?…because the gains are paid on a net basis and positions that have lost many are far outpaced by those that have returned a gain.

Some ugly examples:

  • American Funds Growth Fund of America is expected to pay out 7% of its assets in capital gains.  This will represent the first distribution since the beginning of the financial crisis.
  • Vanguard Explorer is expected to pay out 10% of its assets in capital gains.  This marks an increase from the 2% distribution last year and the 0% distributions from 2009-2011.
  • Fidelity Capital Appreciation – 9%.
  • Vanguard Capital Value – 10%.
  • Vanguard Mid Cap Growth – 10%.
  • Royce Low-Priced Stock – 17%.
  • Lord Abbett Classic Stock – 30%.  Wow!
  • Lord Abbett Small Cap Value – 22%.
  • BlackRock Capital Appreciation – 14%.
  • BlackRock Small Cap Growth – 29%.  Wow!
  • BlackRock US Opportunities – 20%.
  • T. Rowe Price New America Growth – 10%.
  • Janus Forty – 16%.
  • Janus Venture – 13%.
  • Longleaf Partners Small-Cap – 14%.

Mutual funds that will be hit hardest are those where shareholders have been net redeemers as portfolio managers are forced to liquidate positions (and, thus, realize gains) to raise cash to meet redemptions.  For example Calamos Growth had $2.4 billion in net outflows through the end of October representing 35% of its assets.  The expected YE capital gains distribution is a whopping 25% of the fund’s NAV.