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Are Tax-Efficient Funds a Thing of the Past?

Plus, Fidelity's new COO, and more.

Morningstar Analysts, 06/01/2009

Morningstar's fund analysts cover 2,000 mutual funds. Their full analyst reports, including Stewardship Grades, are available in Morningstar Principia Mutual Funds Advanced and Morningstar Advisor Workstation Office Edition.

Within the past few weeks, two fund families announced plans to do away with some of their tax-efficient funds. The most recent casualty was PIMCO Fundamental Advantage Tax Efficient Strategy PFEAX, a long-short fund that was around for less than a year. Although it fared better than two thirds of its peers during its short life, it only attracted $5 million in assets and will be liquidated June 30, 2009.

The news comes on the heels of T. Rowe Price's announcement that it will merge away two tiny tax-managed funds that had suffered from poor performance and had trouble gathering assets, leaving just one tax-managed fund in its lineup.

Although the changes make sense given the circumstances, it's rare to see respected fund shops fold or merge funds. It begs the question: Do we need tax-efficient funds? Lately the answer might seem to be no. Most funds amassed large tax-loss carryforwards during the 2007-09 bear market. Those tax losses automatically make the funds more tax-efficient, at least for a while. In fact, investors who are conscious of tax implications have plenty of good options that don't fall under the tax-managed umbrella. That dims the appeal of those that do.

It's also possible that taxes are the last thing on investors' minds after dealing with such steep losses in 2008. Many investors are probably just trying to figure out if their portfolios have the right asset mix and whether their funds ended up being too risky, never mind worrying about taxes.

Another common criticism of tax-managed funds is that they're too gimmicky and are hard to market to investors. This could explain the trouble that some have had generating assets. Over the years, some funds have even removed mention of tax efficiency from their names to maintain broader appeal, in some cases to no avail. Earlier this decade, the now-defunct Allianz Tax-Managed Growth changed its name to Allianz Targeted Core Growth, only to later fold due to lack of interest. Columbia and American Century have also merged away or changed the monikers of tax-efficient funds in the past.

Despite the potential roadblocks that some tax-managed funds have faced, nearly 50 still exist today. These funds include a variety of investment styles, from large-blend to small-growth to international. Some have been around for a while, like the 43-year-old Eaton Vance Tax-Managed Growth CAPEX, but most have been founded during the last 10 years. And while not all are knockouts in terms of performance, there are some standouts, like Analyst Picks Vanguard Tax-Managed Balanced VTMFX and Vanguard Tax-Managed Small Cap VTMSX. (They aren't standouts right now, but Vanguard Tax-Managed Capital Appreciation VMCAX and Vanguard Growth & Income VQNPX also are picks)

It's also worth noting that there are plenty of funds that technically don't follow a tax-managed mandate but are still tax-friendly. Managers who follow a low-turnover approach, like Bob Goldfarb and David Poppe at Sequoia SEQUX, benefit shareholders by minimizing capital gains. Index funds also are generally tax-efficient.

Whether tax-efficient in name or not, it's always a good idea to investigate a fund's tax implications if it's destined for a taxable account.

Fidelity Bolsters Its Executive Ranks
Fidelity has named Jacques Perold chief operating officer of asset management, a newly created role that will oversee all of the firm's asset-management groups, including Fidelity Management & Research Company, Pyramis Global Advisors, and Strategic Advisers. Perold has been with Fidelity since 1986, most recently serving as president of Geode Capital Management LLC, an independent investment firm that was originally a subsidiary of Fidelity.

The appointment is the latest in a string of changes to Fidelity's ranks. Most recently, Brian Hogan was named head of equities after Walter Donovan departed for crosstown rival Putnam.

Wintergreen's Battle Ends
David Winters of Wintergreen Advisers--adviser to the Wintergreen Fund WGRNX--was somewhat victorious in his proxy fight against Consolidated-Tomoka Land CTO, one of the portfolio's holdings. As previously reported, Winters submitted several shareholder proposals that were voted on at the firm's annual meeting in mid-May. The voting was in his favor for several proposals, including limiting board size to 11 members and adoption of an independent board chairman policy. One of his three independent nominees for the board of directors was also approved. Winters' activism stemmed from his disapproval of how the company has been run.

Vanguard Lowers 529 Fees in Nevada
Participants in Vanguard's 529 college-savings plan in Nevada will soon see a little cost relief. Starting June 1, fees for the plan's 19 portfolios will drop by as much as 0.10%, with total expense ratios ranging from 0.44% to 0.66%.

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