Last Year's Losses Easing This Year's Capital Gains Distributions

It's capital gains season, but despite this year's strong rally there still may not be many gains for funds to distribute. Heading into the final months of 2009, many mutual fund companies have either announced or are preparing to announce their funds' estimated capital gains distributions for the year. Dodge & Cox, Longleaf, and Baron Funds have said that they don't expect any capital gains distributions this year, and Osterweis has indicated that it expects minimal, if any, capital gains distributions for 2009.  T. Rowe Price (TROW) also released its estimates, and the firm expects only a few funds to pay out small capital gains distributions. Fidelity's announcement also indicated very few capital gains distributions. This is in sharp contrast to last year, when many funds distributed gains realized in the runup to the bear market while the market was plunging. This year many funds are using severe losses sustained in 2008 to offset more recent gains. Funds can use those losses to offset future gains for as many as eight years. So, an upside to last year's debacle is that a lot of funds should be more tax-efficient in coming years.

Morningstar calculates funds' potential capital gains exposure on a monthly basis (click here for more details). PCGE estimates the percentage of a fund's holdings that represent gains, and it serves as a guideline for investors regarding the likely tax costs of investing in a fund. When considered with other factors, such as turnover and strategy, PCGE can help identify funds that might make big capital gains distributions in the future.

We looked at the potential capital gains exposure for the 25 biggest funds and found they fell into three buckets. Even though the market has roared back since early March, the bear market's impact remains evident in the fact that 15 of the 25 funds have negative potential capital gains exposure, meaning investors shouldn't expect any distributions, at least in the near term. Dodge & Cox's funds have the lowest potential capital gains exposure in the group:  Dodge & Cox International Stock (DODFX) clocks in at negative 26.3% while  Dodge & Cox Stock's (DODGX) is negative 23.0%.

The second bucket includes six funds with potential exposure in the low single digits, like  American Funds Investment Company of America (AIVSX) at 3.3%. It should be relatively easy for managers with low-single-digit PCGEs to offset their funds' gains with losses.

Finally, four funds register slightly higher potential gains exposure, like  American Funds EuroPacific (AEPGX) and  Vanguard 500 Index Investor (VFINX), at 15.8% and 11.3%, respectively. But given these funds' tax efficiency and their low turnover ratios, our guess is that investors in these funds won't feel much of a tax bite, if any. In fact, Vanguard 500 hasn't issued a capital gains distribution in a decade or so.

Potential Capital Gains Exposure for 25-Largest Funds

  Assets ($Mil) Potential Capital Gains Exposure Total Ret % YTD (Daily) Dodge & Cox International Stock (DODFX) 35,310 -26.33 39.73 Dodge & Cox Stock (DODGX) 39,993 -23.00 22.17 Franklin Income (FKINX) 47,431 -21.79 27.52 American Funds Inc Fund of Amer (AMECX) 62,994 -17.75 18.18 Vanguard Windsor II (VWNFX) 33,320 -15.15 18.70 American Funds Capital Inc Bldr (CAIBX) 78,277 -14.83 15.88 Vanguard Total Stock Mkt Idx (VTSMX) 110,499 -13.86 19.16 American Funds Capital World G/I (CWGIX) 79,339 -11.85 25.23 American Funds Bond Fund of Amer (ABNDX) 39,689 -10.71 14.38 American Funds American Balanced (ABALX) 46,637 -8.10 15.55 Vanguard Institutional Index (VINIX) 65,233 -7.61 17.90 American Funds Washington Mutual (AWSHX) 48,684 -7.33 10.95 American Funds Fundamental Investors (ANCFX) 42,692 -5.82 23.90 Fidelity Diversified International (FDIVX) 36,545 -4.49 24.78 American Funds Growth Fund of Amer (AGTHX) 149,259 -2.20 24.80 BlackRock Global Allocation  32,664 0.46 15.64 Vanguard GNMA (VFIIX) 36,115 3.13 5.30 American Funds Invmt Co of Amer (AIVSX) 59,244 3.29 18.65 Vanguard Wellington (VWELX) 45,270 3.97 16.88 PIMCO Total Return Instl (PTTRX) 185,693 4.09 13.24 Vanguard Total Bond Market Index (VBMFX) 63,567 4.98 6.05 American Funds New Perspective (ANWPX) 42,129 7.42 28.28 Fidelity Contrafund (FCNTX) 59,465 7.55 19.44 Vanguard 500 Index Investor (VFINX) 89,218 11.36 17.79 American Funds EuroPacific Gr (AEPGX) 94,945 15.79 31.88

Bogle Small Cap Growth Reopens
 Bogle Small Cap Growth  will reopen to new investors on Nov. 1. This Fund Analyst Pick had been closed to new investors since 2002. Assets at the fund reached a high of $157 million at the end of 2006 but stood at about $90 million at the end of September 2009. Manager John Bogle Jr. has managed this quantitative-driven offering since its 1999 inception and has a long history of managing quantitative portfolios. Although the fund stumbled badly in 2008, this year through Oct. 28 it's up 30.6%, beating 85% of its small-blend peers. It also held up well in the previous bear market and handily beats its peers since inception. This is a good chance for investors to get into a top small-blend fund.

Peltz Joins Legg Mason Board
Earlier this week, billionaire activist investor Nelson Peltz was named to  Legg Mason's  board after building up a 4.3% stake in the asset manager via his firm, Trian Fund Management. Peltz is widely known for amassing big stakes in companies, gaining a board seat, and then pushing for changes in management or strategy. So far, he hasn't indicated any major plans; Morningstar senior equity analyst Greggory Warren covers Legg Mason and notes in his recent  report that "Peltz seems to be content with Legg Mason's recent strategic initiatives and has agreed to vote Trian's shares in favor of Legg Mason's current slate of director nominees."

Fidelity and Destiny
Fidelity recently filed with the SEC to allow investors who redeemed an investment in one of the firm's Destiny Plans to invest in any of Fidelity's Advisor funds load-free. The Destiny Plans are contractual investments, offered by financial advisors, that require investors to make small monthly payments into the fund for a period of 10 or 15 years.

Baron Ventures into Real Estate
Ron Baron announced last week at Baron Capital's 18th annual investment conference that the firm is preparing to launch its first real estate fund. It's expected to come out in late December. The real estate category is up 12.3% for the year as of Oct. 28.

Etc.
Old Mutual Analytic Global  began liquidating assets on Oct. 22.

Touchstone JSAM Institutional Value  has announced that all assets will be liquidated by Dec. 7.

Shareholders of Principal Ultra Short Bond  are being asked to approve a merger into Principal Money Market. The fund has a three-year annualized total return of negative 8%, which lands in the 94th percentile of the ultra-short bond category.

Shareholders of MTB Multi Cap Growth  are being asked to approve a merger into MTB Mid-Cap Growth .

MEMBERS Small Cap Growth  will merge into MEMBERS Small Cap Value  on Nov. 27.

Dunham Emerging Markets Stock (DAEMX) will be changing subadvisors from Van Eck Associates to Marvin & Palmer Associates on Nov. 1. David L. Schaen will be the new portfolio manager.

Kenneth Doerr is off the management team of Evergreen Mid Cap Growth  and Evergreen Small-Mid Growth .

Matthew Patsky is no longer a portfolio manager of  Winslow Green Growth  and Winslow Green Solutions . The funds will be solely managed by Jackson Robinson.

James Welch replaces Douglas Gaylor as portfolio manager of Dreyfus AMT-Free Municipal Bond (DMUAX).

Mutual fund analyst David Falkof contributed to this report.