It’s capital gains distribution season, and big tax bills are on the way for some fund investors.
A manager’s trading throughout the year will inevitably cause some short- and long-term gains, all of which get passed on to the investor. Investors are also shifting assets from mutual funds to more tax-efficient exchange-traded funds. Funds with high outflows often come with high capital gains, because managers are frequently forced to sell securities to meet redemptions.
This is the time of year when fund companies try to give investors a sense of how big their tax bill will be by estimating how much their funds will distribute in income and capital gains between late November and the end of the year. These gains are only an immediate concern for taxable accounts. Any funds in a 401(K), IRA or other tax-deferred account won’t be taxed until you pull out the money.
Typically, funds’ distributions amount to 5% to 10% of a fund’s net asset value, according to
Morningstar.
Investors in some popular funds are in for a big surprise with distributions in excess of 10% and 20%. The final percentage will vary, based on the fund’s net asset value at the time of distribution.
Last year the broad stock market plunged 18%, handing fund managers an opportunity to harvest losses to offset potential gains. But some areas of the market—such as large-cap growth—have rebounded in 2023, and many funds still have long-term winners on the books thanks to the long bull market before 2020, said Stephen Welch, a senior manager research analyst for equity strategies at Morningstar Research Services, in the firm’s 2023 capital gains roundup.
“Since investors continued to pull money from traditional actively managed funds in the first nine months of 2023, many money managers had to realize gains to meet redemptions,” he said. “Funds must pass those long- and short-term proceeds to shareholders who, if they own their funds in taxable accounts, must pay taxes.”
The Morningstar report focuses on strategies with at least 4% in estimated distributions. Some firms, including the world’s biggest asset manager BlackRock (ticker: BLK) and rival Vanguard, the second-largest asset manager, will release estimates later in November.
Funds from Champlain, FPA, Lord Abbett, and Oakmark expect to distribute less than 4% of their NAV in capital gains, according to the roundup.
The 20-percenters include funds from familiar firms such as Columbia Threadneedle,
Diamond Hill
(DHIL), Delaware Funds by Macquarie,
Federated Hermes
(FHI), and
JPMorgan
(JPM).
The Columbia Real Estate Equity Fund (CREEX) has estimated it will pay out 24.8%. Welch noted that by law real estate investment trusts have to pay out 90% of income to shareholders, so this distribution isn’t out of the ordinary.
The Diamond Hill Small Cap Fund (DHSCX), meanwhile, estimates a “whopping” distribution of 23.1%. “In the 12 months ending in September, the fund’s assets have shrunk by nearly 25% owing to outflows,” said Welch.
Several Delaware funds will make some of the largest distributions, including six that will likely pay distributions in excess of 10%, according to the report. The Delaware Ivy Value Fund (IYVAX) estimates a distribution of 29% after suffering outflows of nearly 50% this year.
Two Federated Hermès strategies—Federated Hermès Kaufmann Large Cap Fund (KLCKX) and Federated Hermès Max Cap Index Fund (FMXKX)—will likely distribute about 25% in capital gains, while the JPMorgan Tax Aware Equity Fund (JPDEX) has estimated it will distribute 21.4%.
“Ironically, [the fund] will likely distribute at least 20%; the $828 million in assets fund has seen more than $240 million in outflows in 2023,” said Welch.
Write to Lauren Foster at [email protected]
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