Ben Franklin reminded us that one of the few certainties in life is taxes. This year some investors might see a slightly higher tax bill as they get a bit more than they bargained for in year-end distributions. For most fund companies, the capital gains distributions in December hurt more than previous years and may be some of the largest since the financial crisis. Putting things into perspective may help alleviate the pain.

Taking a closer look at the December distributions, the US asset classes had the highest capital gains distributions with US Small cap funds distributing nearly 12% of their NAV on average and large caps distributing about 10%. International asset classes had lower distributions than their domestic counterparts with about 6% and 7% of gains being distributed in International Large and International Small funds respectively. While those numbers may sound high, it is estimated that nearly 500 funds distributed 10% or more in capital gains this year.1
post52_image2*Source: Morningstar Direct (2015).The Morningstar average cap gain% of NAV is the average latest capital gain as of December 2014 for all the funds in the named Morningstar Category.
Seeing large average distributions in many of these Morningstar categories also emphasizes the importance of keeping turnover low. The turnover provides an indication of the amount of buying and selling that is taking place in a fund. As fund companies are turning over their holdings they have increased potential for taxable events that may be passed on to the end investor. While turnover doesn’t tell the entire story in regard to higher distributions it can give us insight into the tax efficiency of a fund.
Although higher distributions may not sound ideal, they are partially the result of many years of positive market performance. In fact, the S&P 500 TR representing domestic stocks has had a cumulative return of nearly 160% over the last six years while the MSCI EAFE NR representing international stocks enjoyed a cumulative return of over 70%.2 During this time, many of the underlying holdings appreciated and had to be sold for a gain. For years, fund companies were able to utilize capital loss carry forwards from the recession to offset the capital gains. However, in 2014 many of the capital loss carry forwards had been used up or could not completely offset the gains, causing a larger than normal distribution. This is not the first time this has happened either, as there was a run up in distributions in 2007 after the capital loss carry forwards from the dot com bust had been used up.
We know higher distributions can be a pain point, but with the great performance we have had since 2008 it is to be expected that at some point the fund companies would need to increase their distributions. Keeping that in mind, investing in a low turnover, patient trading strategy may be your best option to realize those long term gains seen in the market.
1 Source:
2 Source: DFA Returns
Past performance does not guarantee future results.
All investments involve risk, including the loss of principal and cannot be guaranteed against loss by a bank, custodian, or any other financial institution.
Stock investing involves risks, including increased volatility (up and down movement in the value of your assets) and loss of principal. International markets involve additional risks, including, but not limited to, currency fluctuation, political instability, foreign taxes, and different methods of accounting and financial reporting. As a result, they may not be suitable investment options for everyone.