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| Last Year's Losses Easing Capital Gains Distributions |
| by
Morningstar Analysts
| 11-02-09 |
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It's capital gains season, but despite this year's strong rally there still may not be many gains for funds to distribute. Heading into the final months of 2009, many mutual fund companies have either announced or are preparing to announce their funds' estimated capital gains distributions for the year. Dodge & Cox, Longleaf, and Baron Funds have said that they don't expect any capital gains distributions this year, and Osterweis has indicated that it expects minimal, if any, capital gains distributions for 2009. T. Rowe Price TROW also released its estimates, and the firm expects only a few funds to pay out small capital gains distributions. Fidelity's announcement also indicated very few capital gains distributions. This is in sharp contrast to last year, when many funds distributed gains realized in the runup to the bear market while the market was plunging. This year many funds are using severe losses sustained in 2008 to offset more recent gains. Funds can use those losses to offset future gains for as many as eight years. So, an upside to last year's debacle is that a lot of funds should be more tax-efficient in coming years.
Morningstar calculates funds' potential capital gains exposure on a monthly basis. PCGE estimates the percentage of a fund's holdings that represent gains, and it serves as a guideline for investors regarding the likely tax costs of investing in a fund. When considered with other factors, such as turnover and strategy, PCGE can help identify funds that might make big capital gains distributions in the future.
We looked at the potential capital gains exposure for the 25 biggest funds and found they fell into three buckets. Even though the market has roared back since early March, the bear market's impact remains evident in the fact that 15 of the 25 funds have negative potential capital gains exposure, meaning investors shouldn't expect any distributions, at least in the near term. Dodge & Cox's funds have the lowest potential capital gains exposure in the group: Dodge & Cox International Stock DODFX clocks in at negative 26.3% while Dodge & Cox Stock's DODGX is negative 23.0%.
The second bucket includes six funds with potential exposure in the low single digits, like American Funds Investment Company of America AIVSX at 3.3%. It should be relatively easy for managers with low-single-digit PCGEs to offset their funds' gains with losses.
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