It's getting to be the time of year when mutual funds distribute capital gains to their shareholders. In most years, this “phantom income” is not material. Also, in most years, client portfolios have appreciated, so the additional taxable income recognition is not terribly painful.
This year is different. Many portfolios have declined in value and, because of higher-than-normal fund liquidations, capital gain distributions are high. For example, the Oppenheimer Capital Appreciation Fund is estimating its year-end distributions at 13.07% of net asset value.
T. Rowe Price funds have estimated distributions ranging up to 15% of NAV, and Dreyfus funds are estimating as high as 20%-25% of NAV.
BE PROACTIVE
How will your clients feel if they get hit with a big tax bill after a year of dismal performance? As an adviser, you have an opportunity to be proactive. At a minimum, you should warn your clients of what to expect. And, if you want to be a hero, you can take steps to avoid these distributions. Absent automation, this process can be cumbersome. The process is:
1) Determine which funds estimate high capital gain distributions.
2) Select an alternate mutual fund or exchange-traded fund to substitute for the high-distributing fund prior to posting.
3) Determine which clients hold material positions in the high-distributing fund.
4) Sell and replace shares of the high-distributing fund in cases where the savings is material. This necessitates determining the savings from lowering the
dividend recognition net of potential recognition of gains (or losses) on the sales.
(More: What financial advisers can do for clients beyond picking investments)
Without automation, the best an adviser can do is to warn clients and address the largest bombshells. However, to do that, the adviser must first find out the estimated dividend distribution amounts. Unfortunately, there is no central automated database for this information. But there are tools. At the most basic level, advisers can research each fund company's estimates for their clients' holdings. This will involve searching each company's website.
CAPITAL GAINS DATABASE
A better solution is the
CapGainsValet site. Managed by Mark Wilson, this resource offers an easy way to search fund distributions in one place. There is no charge for using the site; Mark only asks users to make a donation to
JDRF (formerly the Juvenile Diabetes Research Foundation).
BlackRock/iShares maintains a database of over 7,000 funds that is updated continuously as year-end distributions are announced. Advisers can simply provide
BlackRock a list of tickers and the firm will send periodic updates as the estimates come out. This service is combined with a
BlackRock marketing opportunity: They include information on a suggested ETF for each fund, should the adviser want to opt for their product to maintain market exposure.
(More: Closed-end funds trading at steepest discounts in eight years as investors sell ahead of rate increase)
Although the tools for dealing with capital gain distributions are fairly low tech, advisers need to work with what's available and not let this year's distributions wreak havoc for their clients.
Sheryl Rowling is the chief executive of Total Rebalance Expert and principal at Rowling & Associates. She considers herself a non-techie user of technology.
