It is a well known fact that actively managed mutual funds can be painful for individual investors since they pass on any capital gains to the fundholder..regardless of how much of that gain occurred when the investor held the fund. If the fund has a 50% gain on a stock that it has held for 5 years and sells it you owe tax on the capital gain of the fund even if you have only owned the fund for 5 months. And actively managed funds move in and out of individual stocks and need to sell stocks to raise cash for redemptions if they dont have cash on hand. An index fund does few trades and the situation for ETFs with regards to meeting shareholder inflows or outflows are totally different . As explained here :
A mutual fund manager must constantly re-balance the fund by selling securities to accommodate shareholder redemptions or to re-allocate assets. The sale of securities within the mutual fund portfolio creates capital gains for the shareholders, even for shareholders who may have an unrealized loss on the overall mutual fund investment. In contrast, an ETF manager accommodates investment inflows and outflows by creating or redeeming “creation units,” which are baskets of assets that approximate the entirety of the ETF investment exposure. As a result, the investor usually is not exposed to capital gains on any individual security in the underlying structure.
The net effect is that the return of a fund you own (or whose performance you see listed) is significantly higher than the after tax return for someone that owns the fund,
This year has been a particularly painful one for owners of actively managed mutual funds, As the WSJ notes this has been a very good year for stocks..but it also has been a very big one for investors "getting the message" and moving from actively managed funds to ETFs and index funds. Those outflows mean the fund manager must sell stock to meet the cash needs...and those sales generate taxable gains passed on to the individual investor...and some of those may even be short term capital gains taxed at the same rate as ordinary income. And it seems active managers are no better than individuals in deciding what to sell..it seems they sell winners and hold on to losers...hoping the losers will "come back" and in the process generating a greater tax bill than if they had sold losers or at least made an attempt to match sales of winners to sales of losers to reduce the tax bill (and rebalance their portfolios at the same time.
from the WSJ
There are two forces at work here: The S&P 500 index has gained more than 17% this year, and some sectors are up even more—the type of performance that tends to lead many fund managers to cash in winning stocks to lock in gains. At the same time, as investors continue to shift out of actively managed funds and into passively managed index funds in droves, they made net withdrawals of nearly $240 billion from active U.S. equity funds in the 12 months through Sept. 30, according to Morningstar Inc., causing managers of those funds to sell winners to meet redemption requests.,,,
As of Nov. 5, more than 249 mutual funds are anticipating making capital-gains payouts to shareholders of more than 10% of their net asset values, says Mark Wilson, president of MILE Wealth Management in Irvine, Calif., who tracks mutual funds’ estimates of their capital-gains payouts and posts them on his website, CapGainsValet.com. Just 114 funds made distributions of more than 10% in all of last year, he says.
Not only are the numbers for some distributions eye popping some of the results are ironic
Some surprises
Among the surprise distributions this year are payouts anticipated by the JPMorgan Tax Aware Equity fund (JPEAX) and the PNC S&P 500 Index fund (PIIAX). The Tax Aware Equity fund estimates a payout of 8.9% this year, which is surprising since the fund is supposed to manage its portfolio to reduce capital-gains payouts, says Ms. Benz. J.P. Morgan Asset Management declined to comment.
The PNC S&P 500 Index fund is estimating a payout of more than 22%, according to PNC Funds’ website. It’s “an unusual dynamic” to see index funds make such a hefty distribution, says Mr. Wilson, because their holdings typically don’t change often. A spokeswoman for PNC Financial Services Group Inc. declined to comment
The explanation I could see for the latter fund is that some investors realized that paying a .45% management fee for an S+P 500 index instrument when it can be for basically zero elsewhere was a good reason to sell. This meant the fund needed to sell assets...and generate capital gains distributions.
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