Inevitable Distributions?

Earlier this year, I decided to build a list of mutual funds that were surely going to have large capital gains distributions.  After all, mutual funds with large shareholder redemptions and large embedded gains would have to end the year with large capital gains distributions.  Makes sense, right?

So I searched, sorted, and crunched some numbers to build my Inevitable Distribution List.  I limited the list to the most likely 20 funds.  (I won’t share the list to protect the innocent.)  On average, these funds lost 45% of their assets to shareholder redemptions and they had average embedded capital gains of 40%.

Well… it turns out that my assumptions were not entirely correct.  Ok – my sure bets were not sure at all.

As you can see from the chart above, while half of the funds on my list are expecting distributions higher than 10%, the other half of my list was mostly ignorable.  Yes, my work was better than throwing darts but not as insightful as I expected.

My bottom line – Looking ahead at fund outflows is not worth the exercise.  Instead, spend your time gathering capital gains estimates for all of your holdings to make sure there are no surprises.

2019 Predictions

“Mr. Wilson, are there going to be a lot of large capital gains distributions this year?”

First, please don’t call me Mr. Wilson – that’s my father’s name.
Second, my 2018 guess was in the right range, but off by 11%.  Predicting specific numbers is very difficult.
Third, I’m always happy to provide an opinion, so thank you for asking.

Before presenting my guess, let’s look at how the last several years have stacked up.  The chart below shows the range of “large” fund distributions in the previous five years.  The average is around 380, but the range is enormous!

As you can see from the chart, 2018 saw the highest number of large distributions since I started tracking them.  These numbers are likely the result of nine impressive years of stock market gains as well as the record amount of dollars that are leaving mutual funds.

Expectations are that 2019’s numbers will look similar to 2018.  After all, the stock markets continue to reach new highs and mutual funds are still seeing huge outflows.

Despite these reasons, I think we will see a substantial reduction in these “large” distributions for three primary reasons:

  1. 2018 provided opportunities to take tax-losses – Although losses for 2018 were not too painful, we did see a 20% stock market decline at the tail end of the year.  This decline might have provided the opportunity for mutual fund managers to perform some tax-loss harvesting that’ll result in more reasonable distributions.
  2. Fund managers might have learned a lesson – Large capital gains distributions can lead to very large fund redemptions.  For example, some funds on last year’s Doghouse List saw multi-billion-dollar redemptions.  I’m hoping tax-efficiency became more of a focus for fund managers because of these huge redemptions.
  3. Early numbers are in – A handful of fund firms have already provided distribution estimates, and these numbers are much lower than last year.  (85% of firms have yet to provide distribution details, so this could easily turn around.)  As a distributor of capital gains information, this is not great news.  As a financial advisor and investor, this is great news!

All of these reasons lead me to predict that this season we will see 219 funds with capital gains distributions higher than 10%.

Climatologists and economists are not very good at longer-term forecasting.  I’ll follow their lead and adjust my forecast as more information becomes available.  Stay tuned!

2018 Predictions

Are there going to be a lot of large capital gain distributions this year?

Phil Tetlock’s book “Superforecasting” provides a number of tools which can help us turn our wild guesses into reasonable predictions.  Tetlock’s Superforecasters often started with a “base rate of similar occurring events” so let’s begin there.  After tracking my own list of large capital gains distributions since 2014, I actually have some data to help select a base rate.

The average number of funds with gains in excess of 10% has been around 340.  That’s my starting point.

I have three reasons why I think this year’s numbers should be adjusted upwards:

  1. There are gains on the books – We’ve had a decade of solid returns from the stock markets so funds have lots of gains to be realized and few losses available to offset these gains.
  2. Funds are seeing outflows and are forced to take gains – We continue to see flows out from mutual funds and into ETFs; these trades create additional realized gains for the remaining shareholders.
  3. Early numbers are in – Some fund firms have already provided their distribution estimates and these numbers are ahead of last year.  Admittedly, this is a little like predicting the winner of a running race after the first lap.

So… I’ll play the role of a TV pundit and predict that we’ll see 478 funds with capital gains distributions higher than 10%.

Of course, (also like the pundits) I’ll have several reasons to explain why my prediction is off when this is the case.  Either way, I think it makes sense to be monitoring your funds for large distributions and opportunities to save some tax dollars.

 

 

photo credit: N@ncyN@nce The amazing Zoltar via photopin (license)</

Predicting 2017’s Capital Gain Distributions

“How painful will this year’s capital gains distributions be?”

Warren Buffet once quipped: “Forecasts usually tell us more of the forecaster than of the forecast.”  This is one reason I hesitate to forecast what we might see this year for capital gains distributions from mutual funds.  Nonetheless, I’ll reveal a little about myself and will make an educated guess.

Looking Back

I don’t track absolute dollars of fund distributions, but for the last four years I have counted the number of funds that have “large” (more than 10%) capital gains distributions.  As you can see from the chart below, the trend has been favorable to taxpayers.  2014 had over 500 funds that distributed more than 10% in gains.  Last year, barely 100 funds were in that category.

Initial Thoughts

Larger than average fund distributions are generally driven by two factors:

  • Gains – We’ve seen nine nice years of market gains, so it’s no surprise that funds (especially US equity funds) have gains on their books. As funds make trades to rebalance and take profits, they realize taxable gains that must be distributed to fund owners.
  • Fund Liquidations – The last several years has seen a large move away from actively managed mutual funds and into index mutual funds and ETFs. Last year, active managers running US equity funds saw over $260 million in fund outflows and we are seeing similar numbers this year too.  Managers in these funds have to raise cash, and that means selling holdings. This results in realized taxable gains.  There is very little a fund manager can do to be tax efficient in this situation.

Given these two factors, I’m guessing we will see a solid number of large fund distributions in 2017.  My early thoughts were that we’d see numbers somewhere between what we saw in 2015 and 2016.

Where are we now?

As I write this, nearly 30% of the fund firms in my extended database have released their capital gains estimates and the results are interesting.  We are on pace towards 2014’s numbers, and could end up with a year with over 500 funds making 10%+ distributions.  Unfortunately, this doesn’t look like it’s a year where we’ll be able to skip paying attention to fund distributions.

 

 

 

 

 

 

photo credit: Neil Tackaberry wizard via photopin (license)

What Are You Thankful For?

Thanksgiving is my favorite holiday.  We get four days off, gather with our family and friends, and prepare and eat good food.  All of this without the extra “stresses” of the 4th of July or (at our house) Christmas.

Once everyone is seated around the dining room table, we wait for my father-in-law to ask the question “Can we go around the table and each share what we are thankful for?”  This is a longstanding tradition and another reason why I enjoy the holiday.  It’s great to hear answers ranging from “our family’s health” and “Uncle Russ has joined us” to “cranberry sauce!” and “the turkey is not a charred mess.”

Well, I must have been thinking too much about CapGainsValet, because here’s how I answered the question this year:

“I’m thankful for:

  • A smaller Doghouse List. CapGainsValet has been running for the last three years, so we can start to make distribution comparisons.  This year we are definitely seeing fewer of the massive (20%+ of NAV) distributions.

doghouse-trend

  • Fewer distributions higher than 10%. While 20%+ distributions are truly painful, distributions in the 10% to 20% range also increase our tax bills.  Although many planned for another large year for capital gains distributions, I’m guessing this year will be one of the most tax-efficient years we’ve had in a long time.

10-percenters-trend

  • Asset Location. When building out an investment portfolio, we think not only about what goes in the portfolio, but also where those assets should go.  Having the “right” holdings in tax-deferred and tax-free accounts makes capital gains distribution season less worrisome.  Owning active equity managers, alternative funds and many bond funds in taxable accounts creates unnecessary tax drag and reduces long-term after-tax wealth.  (Michael Kitces has excellent tips on asset location – and many other topics – at kitces.com.)

(realizing my wife and kids were rolling their eyes…)

 

  • Oh – and, I’m thankful for my lovely wife, my amazing children and the fact that we all recognize we should be thankful!”

 

 

 

 

photo credit: elviskennedy Fall into Winter – Equinox to Solstice #63 – Turkey via photopin (license)

2016 Distributions, Not Looking Too Spooky

Halloween is the time of year to start thinking about the impact of capital gains distributions from your mutual funds and ETFs.  We’ve spent the last month updating our site and building our Free and Pro databases.  We’ve already made two passes through over 250 fund firm websites looking for 2016 distribution estimates.

As I think about how this year compares to previous years, I have a house full of high schoolers dressed up for a Halloween party.  Some of their costumes match my initial comments for the year:

  • Einstein – Educate yourself.  Misunderstanding the impact of capital gains distributions can cost hundreds or thousands of dollars in extra taxes.  The Articles section of the CGV website has several short pieces that explain beginner distribution concepts as well as more advanced tax saving strategies.
  • Wonder Woman – Heroic firms have already posted 2016 estimates.  Investor friendly firms make their shareholders’ lives easier by posting capital gains information (estimated amounts and distribution dates) early.  We’ve already found this information for nearly 90 firms.  We will continue to cycle through mutual fund firms and post estimates as they become available.
  • Chihuahua – Our doghouse will probably be smaller than usual.  Our annual “In the Doghouse” list compiles funds with estimated distributions over 20% of NAV.  At this time last season, we already found 28 funds with these huge distributions.  This year, we have only eight. It’s early in the year so the list will continue to grow.
  • Ostrich – Do not bury your head in the sand.  While I’m expecting this to be a less dramatic season for capital gains distributions, ignoring them is not a good plan.  We’ve already found over 60 funds that are expecting distributions in the 10-20% range and we’ve seen countless distributions in the 5-10% range.  Planning around (even small) distributions still makes good sense.

Using CapGainsValet should help you get through the remainder of the year without any surprise scares.

 

 

photo credit: Miss Barabanov Bodyless via photopin (license)