Home' Trinidad and Tobago Guardian : December 6th 2015 Contents DECEMBER 6 • 2015 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
MUTUAL FUNDS | SBG11
Never mind that this year
has largely been a dud for
stocks. A tax bill is still
coming for many mutu-
Now that December is here, funds are
lining up to pass along something called a
capital-gains distribution to their share-
holders. It s about as appetising as it sounds.
Investors who hold mutual funds outside
a 401(k) or another tax-advantaged account
must pay taxes on these distributions, even
if they don t sell any shares. And the bills
could be big: More than a dozen funds have
already said they expect to pass along dis-
tributions in coming weeks that are more
than 30 percent of their total assets.
Several factors are behind this year s dis-
tributions, from home-run stock picks made
years ago to the recent surge in corporate
takeovers. But first, a reminder on what
causes distributions and how they affect
When a fund sells a stock, it records how
much it made or lost on it. At the end of
the year, it totals the gains it made from
trading and distributes those gains to share-
Say you hold a mutual fund whose shares
currently trade at US$10 each. That fund
may distribute US$2 per share in capital
gains to you at the end of the year. You have
to pay taxes on those gains if you hold the
fund in a taxable account, even if you didn t
sell any shares. Long-term gains generally
qualify for lower rates than short-term gains.
The value of your holdings won t normally
change as a result of the distribution, which
often gets reinvested in the fund. The price
of each fund share in this example would
drop to US$8 when it made the distribution
of US$2, leaving you with the same US$10
The Fairholme Fund expects to make dis-
tributions of US$11.55 to US$12.35 per share
next week. That s equal to about 35 percent
of the fund s assets, as of Wednesday, and
would dwarf last year s distribution of
US$3.08 per share.
The main reason for the jump is that AIG
did what shareholders hoped it would after
Fairholme Fund bought it in 2010 and 2011:
It surged. AIG generated more than US$2
billion in gains for the fund by June of this
year. And when it sold AIG shares, it record-
ed a big gain.
Another reason for this year s rise in dis-
tributions is the explosion in corporate
takeovers. Companies are finding it difficult
to drum up revenue growth given the still-
tepid global economy, so they re buying
competitors instead. Others are combining
in cross-border deals to lower their tax rates.
At the Jensen Quality Growth Fund, man-
agers expect to pass along distributions of
US$3.74 per share, which is about nine per
cent of its total assets, as of Wednesday.
Last year s was US$1.63.
Earlier this year, one of its investments,
Medtronic, completed its US$42.9 billion
acquisition of Covidien. The deal created a
tax bill. The fund also recorded big gains
from sales of its holdings in Automatic Data
Processing and Equifax .
The fund took the unusual step of explain-
ing what was behind the distribution to
shareholders in a notice on its website and
in general conversations, says Dave Mertens,
managing director at Jensen Investment
"For the most part, investors understand
this is a bit of an anomaly and this is an
unusual year," he says.
A third reason for this year s distributions
is the continued migration of dollars out of
actively managed funds. Investors are flock-
ing instead to the lower costs offered by
index funds. When shareholders ask for
their money back, fund managers may have
to sell some of their investments to raise
more cash. That selling means they may
have to book more gains.
Here are some other factors to keep in
mind as distribution season approaches:
• Only investors in taxable accounts need
to care. If all your funds are in an IRA, these
distributions have no effect.
• If you re looking to buy a fund, it can
pay to wait. When a fund makes a distri-
bution, it goes to all investors regardless of
when they entered. Find out on funds web
sites when they plan to make distributions
and wait until afterward to buy. The flip is
also true: If you re planning to sell a fund,
do so before the distribution.
• Index funds can be more tax-efficient,
but they re not immune. Index funds gen-
erally buy and sell less often than actively
managed funds, which means fewer oppor-
tunities to trigger capital gains. But even
index funds and ETFs can pass along dis-
tributions. Some indexes are likely to have
more turnover than others. A small-cap
growth stock index will probably see its
member list change more than a total stock-
• Some funds are built to be more tax-
efficient. Funds that go by the "tax-man-
aged" label trade less often. They also may
avoid stocks that pay dividends because
that income is taxable.
AP's Stan Choe
Both mutual funds and ETFs hold portfolios of stocks
and/or bonds and occasionally something more exotic,
such as precious metals or commodities. They must
adhere to the same regulations covering what they can
own, how much can be concentrated in one or a few
holdings, how much money they can borrow in relation
to the portfolio size, and so on.
Beyond those elements, the paths diverge. Some of
the differences may seem obscure and wonky, but they
can make one type of fund or the other a better fit for
When you put money into a mutual fund, the trans-
action is with the company that manages it---the Van-
guards, T Rowe Prices, and BlackRocks of the world---
either directly or through a brokerage firm. The purchase
is executed at the net asset value of the fund based on
its price when the market closes that day or the next
if you place your order after the close of the markets.
When you sell your shares, the same process occurs
in reverse. But don t be in too great a hurry. Some mutual
funds assess a penalty, sometimes one per cent of the
shares value, for selling early, typically sooner than 90
days after you bought in.
ETF investors don t face that prospect. As the name
suggests, ETFs trade on exchanges, just as common
stocks do, and the other side of the trade is some other
investor like you, not the fund manager. You can buy
and sell at any point during a trading session at whatever
the price is at the moment based on market conditions,
not just at the end of the day, and there s no minimum
holding period. This is especially relevant in the case of
ETFs tracking international assets, where the price of
the asset hasn t yet updated to reflect new information,
but the US market s valuation of it has. ETFs can reflect
the new market reality faster than mutual funds can.
Another key difference is that most ETFs are index-
tracking, meaning that they try to match the returns
and price movements of an index, such as the S&P 500,
by assembling a portfolio that matches the index con-
stituents as closely as possible. Mutual funds can track
indexes too, but most are actively managed; in that case,
the people who run them pick holdings to try to beat
the index that they judge their performance against.
Actively managed funds must spend money on ana-
lysts, economic and industry research, company visits,
and so on. That typically makes mutual funds more
expensive to run---and for investors to own---than ETFs.
ETFs = lower costs, more efficient
But passive management isn t the only reason that
ETFs are typically cheaper. Index-tracking ETFs have
lower expenses than index-tracking mutual funds, and
the handful of actively managed ETFs out there are
cheaper than actively managed mutual funds.
Clearly something else is going on. It relates to the
mechanics of running the two kinds of funds and the
relationships between funds and their shareholders.
Mutual funds and ETFs are both open-ended. That
means that the number of outstanding shares can be
adjusted up or down in response to supply and demand.
How and why they do it aren t the same, however.
When more money comes into and then goes out of
a mutual fund on a given day, the managers have to
alleviate the imbalance by putting the extra money to
work in the markets. If there s a net outflow, they have
to sell some holdings if there s insufficient spare cash
in the portfolio.
In an ETF, because buyers and sellers are doing business
with one another, the managers have far less to do. The
ETF providers, however, want the price of the ETF (set
by trades within the day) to hew as closely as possible
to the net asset value of the index.
Despite flat market,
many funds will
deliver taxable gains
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