Tax-Managed Funds Lose Appeal Following Collapse In Equities

by Phillip Morton, Investors Offshore.com

30 April 2003

Popular in the bull market of the 1990s, tax managed or tax efficient funds have now become less attractive after three years of declining equity prices. Recent results show ordinary equity funds are now as tax efficient as tax managed funds, with heavy losses offsetting capital gains.

Tax efficient funds attempt to minimise the tax burden on the investor by balancing gains against losses. They often do this by selling shares at a loss and buying shares that attract a small dividend payout. The turnover in such funds is generally a lot lower than ordinary funds.

Figures from Morningstar, a Chicago-based investment research firm, show that in the five years to March 31 2003, after-tax returns for investors in the top income bracket were a negative 3.9 percent for tax-managed funds. This compares favourably against the 5.2 percent losses experienced by other equity funds.

However, in the last twelve moths, tax-managed funds have fared little better than other equity funds. The average tax-managed fund was down 26.83 percent in the last year compared to an average loss of 27.2 percent in other equity funds.

Mutual funds have to distribute 98 per cent of their capital gains and income to shareholders annually. However, for tax purposes, capital losses can be retained by the fund to offset gains for up to eight years and some analysts suggest funds will be unlikely to distribute capital gains for at least five years.

Morningstar has tracked 114 tax-managed funds for potential capital gains and has found 88.6 percent have net capital losses that can be used to offset gains. Similarly, 90.1 percent of the 5,961 equity funds tracked also have capital losses that can be offset against gains.

However, whilst tax-managed funds may remain unattractive in the short to medium term, some analysts predict that benefits can still be realised if a longer term view is taken.

"I do think someone investing for 15 years can still look at one of these tax-managed funds," said Scott Cooley, a senior analyst at Mornngstar in a New York Times report.

Nevertheless, should President Bush's plans to eliminate taxation on dividends make it onto the statute book it could eliminate the need for tax-managed funds altogether. The President's tax plan would also raise the limit to $45,000 that can be invested in tax efficient funds. So it would seem the future for these investment vehicles seems uncertain at best.

Recommended