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Fund Spy

Tax-Managed Funds Are Dead; Long Live Tax Management

Investors avoid these offerings, but more managers are looking at taxes.

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The phrase "tax-managed" is death for marketers. Nothing seems to scare away investors more than those words. Although the idea of managing a portfolio in order to maximize returns after taxes makes all the sense in the world, investors don't want to hear about it.

Last week, a tax-managed fund, Allianz Targeted Core Growth was liquidated for lack of interest. The $24 million fund used to be called Tax-Managed Growth. That name was abandoned in November 2005, but the new name came too late to save the fund. Meanwhile, Columbia has announced plans to merge $250 million Columbia Tax-Managed Growth (STMAX) into  Columbia Large Cap Growth  (LEGAX). Even back in 2003, American Century removed the tax-managed tag from one of its funds as American Century Tax-Managed Value was rechristened  American Century Capital Value  (ACTIX).

Consider that  Vanguard Tax-Managed Growth & Income (VTGIX), a tax-managed version of  Vanguard 500 Index  (VFINX), has $3 billion in assets, while Vanguard 500 has $110 billion in assets. The tax-managed fund charges 4 basis points less than Vanguard 500 and has even slightly outperformed Vanguard 500 on a pretax basis. Likewise,  Vanguard Tax-Managed Capital Appreciation (VMCAX) is about a twentieth the size of  Vanguard Total Stock Market VIPERs (VTI).

For whatever reason, investors haven't embraced funds with "tax-managed" in their names even though this behavior doesn't seem rational. Yet, I'd wager that a greater percentage of assets in the fund industry are managed with taxes in mind than ever before.

When Columbia announced plans to merge away its tax-managed fund, it pointed out that all of its funds were managed in a much more tax-aware way than they had been in years past. That means harvesting losses to offset gains and carefully tracking gains and losses in each stock lot held in the fund. It's a trend common throughout the fund world. Managers are paying closer attention to taxes than they have in the past; they just don't put that fact in their fund name.

The biggest driver, though, is mutual funds traded on exchanges (aka ETFs). The vast majority of these funds have a clever tax structure that helps management to easily avoid making any capital gains distributions. ETFs have taken in over $335 billion and continue to grow at a good clip.

Good thing they weren't called "Exchange-Traded Tax-Managed" funds, or they'd be closer to $300 million instead of $335 billion.

When you're buying for your own taxable account, be sure to investigate funds' tax-managed policies. Chances are some of the ones that look most appealing to you are following at least some tax-management guidelines. If not, you may find a close equivalent. ETFs and Vanguard's tax-managed funds are great alternatives to traditional index funds.

Russel Kinnel does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.