See who missed 2009's party.
With many markets having rallied like crazy since March, this holiday season likely feels far more enjoyable for investors than last year's did. The fact that most equity funds aren't paying out taxable capital gains distributions this year adds to the feeling of relief.
But not everyone is sharing in the joy. Here are two funds whose shareholders won't be able to swap success stories around the fireplace in the coming weeks.
When Safe Isn't Safe
As I noted in a column a few months ago, the concepts of "safe" and "risky" can be misleading. Depending on when and how you buy them, even U.S. Treasury securities can be risky plays. Shareholders of Vanguard Extended Duration Treasury Index
How is that possible? If you remember, in late 2008 panic in the markets sent many worried investors flooding into U.S. Treasuries in search of something--anything--that was unlikely to go to zero. As a result, prices of these securities soared. Then in 2009, these prices fell back in a hurry. Even though many questions remained about the strength of the world's economies and financial institutions, the feelings of abject panic subsided as government support programs expanded. As a result, many investors shifted out of the ostensibly safe havens to which they had fled.
Funds that owned the longest-term Treasuries were hit hardest by this reversal. But the Vanguard fund, which invests largely in Treasury "strips" that react even more strongly to such moves than conventional Treasuries do, suffered the biggest loss among the small contingent of long-term government funds.
To add to the pain, shareholders slammed by this monster loss will receive taxable capital gains distributions from their fund this year. That odd situation owes to the immense gains earned by the fund in 2008. As explained in the fund's annual report, some shareholders withdrew their money in 2009, and the fund had to sell holdings to generate cash. It realized gains as a result. Those shareholders remaining in the fund are stuck with the tax bill. (The shareholders who took their gains and ran may not emerge scot-free. If they held those shares in a taxable account, they're liable for taxes on their own gain.)
Shareholders can't say they weren't warned. The "President's Letter" included in the annual report of Aug. 31, 2009, specifically alerted shareholders to expect a "sizable" capital gains distribution in December.
In fact, this news could have been worse. Vanguard Extended Duration Treasury is not aimed at retail investors, so it's unlikely that ordinary Joes felt the brunt of this double-whammy. The fund has a steep minimum and is designed to be used as one part of a broad, complex strategy by pension-fund managers. Such managers probably aren't thrilled with a 35% loss, either, but at least they were likely to know exactly what was entailed in this fund's strategy, and to have owned a variety of other assets that performed far better this year. Depending on the circumstances, they may not have to pay taxes on the distribution, either.