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Potential Capital Gains Exposure

Potential capital gain exposure (PCGE) is an estimate of the percent of a fund's assets that represent gains. PCGE measures how much the fund's assets have appreciated, and it can be an indicator of possible future capital gain distributions.

Morningstar calculates potential capital gain exposure (PCGE) to give investors some idea of the potential tax consequences of their investment in a fund. PCGE measures the gains that have not yet been distributed to shareholders or taxed. It is especially relevant for investors who are considering a new purchase of a fund. If there are a lot of gains embedded in the fund, the investor may potentially receive capital gain distributions for gains that happened before they purchased the fund.

A positive PCGE means that the fund's holdings have generally increased in value. For example, if a fund started with $2,000, gained $500 and lost $100, the fund's PCGE would be 17%, i.e. the net $400 gain divided by the total net assets of $2,400. The fund can either continue to hold the securities that appreciated or it can sell them. When a fund sells a security at a gain, it must distribute substantially all of those gains to shareholders that year. Investors then must pay taxes on those gains. So, a high PCGE can indicate the potential for upcoming capital gain distributions.

A negative PCGE means that the fund has reported losses on its books. For example, if a fund started with $2,000, gained $100 and lost $500, the fund's PCGE would be -25%, i.e. the net $400 loss divided by the total net assets of $1,600. The fund may be able to use those losses to offset future gains, thereby reducing the possibility of a capital gain distribution. Thus, investors should expect funds with negative capital gain exposure to be highly tax-efficient going forward.

Because the fund's asset base serves as the denominator in this calculation, a change in assets from the sale or redemption of shares can greatly influence a fund's potential capital gain exposure. As a fund's asset base grows, the tax impact of previous gains to shareholders is diminished. Conversely, a shrinking asset base amplifies the tax impact of past performance.

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