With another year of double-digit returns in the stock market, tax bills continue to grow.
Funds that are at the greatest risk of making big capital gains distributions are those that have seen significant asset outflows and have sizable potential capital gains exposure. In looking for funds at risk of making large capital gains distributions in 2021, we focused on those that, through June 2021, have seen outflows equal to 5% of their total assets at the beginning of year coupled with low cash allocations. We also looked for funds with potential capital gains exposure of more than 50% of assets.
To further identify potentially large capital gains distributions, we sought out funds with sizable one-year tax-cost ratios and those that had seen increases of more than 50% in their one-year tax-cost ratio relative to its five-year average. This ratio looks at how much taxes take out of a fund’s annualized return; the higher it is, the worse for you. The following four funds appear to be at risk for large capital gains distributions. All of the data quoted is through June 30, 2021.
Hennessy Focus Investor HFCSX
This mid-growth fund earns a Morningstar Analyst Rating of Bronze. It made a capital gains distribution equal to about 22% of assets in 2020, giving it the highest tax-cost ratio over the past year of Morningstar 500 funds. It could see something similar in 2021; the fund has seen outflows equal to about 11% of beginning 2021 assets after a difficult 2020, where the fund’s performance ranked in the bottom decile of its peer group. The managers run a concentrated strategy that has just 18 holdings with more than 75% of assets in its top 10 and low annual portfolio turnover. However, it has a potential capital gains exposure of 80% of assets and had a large increase in its one-year tax ratio relative to its five-year average, signaling a sizable distribution could be looming.
Neuberger Berman Multi-Cap Opportunities NMUAX
This Bronze-rated large-blend fund has been a solid performer relative to its peers over the past decade, but its third-quartile performance in 2019 and 2020 has hurt. Estimated net outflows through June were equal to about 20% of the fund's beginning asset base. Cash tends to be negligible here and is often below 1% of assets. The fund does have 45 holdings, giving manager Richard Nackenson some flexibility in selling shares to meet redemptions, though its capital gains exposure is equal to 66% of assets. It also has seen a spike in its one-year tax-cost ratio relative to its five-year average.
ClearBridge Aggressive Growth SHRAX
This Neutral-rated large-growth fund made a capital gains distribution equal to about 21% and 32% of assets in 2019 and 2020, respectively. Something similar or worse may be on the way in 2021. Estimated net outflows through June were equal to about 6% of the fund’s beginning asset base, and cash tends to be negligible here. The strategy has low turnover and its 53 holdings give it some flexibility in selling shares to meet redemptions, but its potential capital gains exposure of 84% of assets is still one of the highest of the Morningstar 500 funds.
T. Rowe Price Real Estate TRREX
Neutral-rated T. Rowe Price Real Estate’s annual performance has ranked close to the worst decile of peers in each of the past three calendar years and has seen estimated net outflows through June equal to 7% of beginning 2021 assets. The fund also had the largest tax-cost ratio over the past year of Morningstar 500 funds, and that ratio more than doubled relative to its five-year average. The fund’s low annual portfolio turnover helps, but it also has a potential capital gains exposure of 55%, which could point to continued large distributions in the future.