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Caution: Tax Bills Ahead

Dan Culloton

Ah, fall. The season of dubious pumpkin recipes, Chicago Bears quarterback controversies, and mutual fund capital gains distribution estimates. Yes, we're well into the time of year when fund companies try to give their investors an idea of what their 2013 tax bills may look like by estimating how much their funds will distribute in income and capital gains. After four years of rebounding equity markets, the companies have good news and bad news: Most funds have made money, but in many cases--because of manager changes, persistent outflows, or a depleted store of losses that can be used to offset realized gains--funds will make (or, in some cases, have already made) sizable distributions.

In recent weeks, Morningstar analysts trolled through the distribution estimates from some of the largest and most prominent fund families and found some whoppers and a couple of trends. Here are some funds that, based on estimates issued in October and November, expect to make hefty distributions in mid- to late-December.

Modest Gains From Big Firms
At Vanguard, currently the largest fund family, Vanguard Explorer (VEXPX), Vanguard Capital Value (VCVLX), and Vanguard Mid Cap Growth (VMGRX) will make the biggest gains in the family as a percentage of net asset value--about 10% each. Vanguard Explorer, an actively managed subadvised fund, has seen steady outflows since 2006 while posting decent gains. Nearly half the fund's assets represent gains, and it has continued to see outflows this year through October, so a healthy distribution is no surprise here. Vanguard Capital Value is an aggressive, high-turnover contrarian fund that has soared a cumulative 325% from the March 2009 financial crisis nadir through Nov. 19, 2013, more than enough to burn through the losses it realized in a difficult 2007 and 2008. Vanguard Mid Cap Growth has seen modest inflows this year, but it also has an above-average turnover rate and is sitting on a fair amount of gains.

The biggest estimated capital gains distributions at Fidelity Investments include Fidelity Latin America (FLATX), which will distribute a gain of about 17% of its NAV. Fidelity Trend (FTRNX) and Fidelity China Region (FHKCX) each will distribute capital gains amounting to more than 11% of their NAVs. About 20 other Fidelity funds will distribute gains amounting to 5% to 10% of NAV, including Fidelity Capital Appreciation (FDCAX) (9%), Fidelity Mid Cap Value (FSMVX) (8%), Fidelity Contrafund (FCNTX) (6%), Fidelity Magellan (FMAGX) (5%), and Fidelity New Millennium (FMILX) (5%). Nearly half of Fidelity Capital Appreciation's distribution and more than 40% of Fidelity Magellan's payout will be short-term gains, which are taxed at a higher rate.

At American Funds, the biggest distribution estimates come from American Funds AMCAP (AMCPX), American Funds Growth Fund of America (AGTHX), and American Funds SMALLCAP World (SMCWX) which all report that they will pay out distributions of 5% to 8% of their NAVs. American Funds Investment Company of America's (AIVSX) distribution could approach 9% of NAV, according to estimates. Many American Funds have endured outflows in recent years. Growth Fund of America and Investment Company of America saw another $8 billion and $4 billion leave, respectively, in the first 10 months of 2013. But managers at the family contend that outflows have not forced them to realize the gains; rather, after four years of generally rising equity markets, the funds have little if any realized and unrealized losses that can be used to offset the gains.

Going With the Outflows
Persistent redemptions appear to have influenced Calamos Growth's (CVGRX) estimated distributions. For the third year in a row, it looks like the fund will issue a big distribution, this one amounting to nearly 25% NAV. Inves­tors pulled a net $2.4 billion from Calamos Growth through October 2013 (40% of its total assets at the start of the year), and the fund has gained 26% for the year through Nov. 1. It made capital gains distributions equal to 5% and 8% of its net asset value in 2011 and 2012, respectively. Continued outflows in 2014 could spell more tax bills.

At first glance, Royce Low-Priced Stock (RYLPX) doesn't appear primed to make a big distribution. It has struggled since the start of 2011, registering a slight loss from then through Nov. 19, 2013, while its typical peer has gained an annualized 14%. The fund also trades fairly infrequently; portfolio turnover has aver­aged 23% annually over the past five years. But Royce estimated in mid-September 2013 that the fund would make a distribution equal to 16.6% of its NAV to those who own the fund in a taxable account as of Dec. 4. Investors have pulled a net of $2.6 billion from the fund since the start of 2011, which means its realized gains are spread over a far smaller asset base ($1.7 billion).

Domino Effects
Some of the biggest distributions as a percentage of net assets will come from funds that recently got new managers and/or strategies. Such changes can lead to big gains distributions as new skippers reposition portfolios to their liking. Lord Abbett Classic Stock (LRLCX), for example, got new managers in June and estimates it will pay out almost 30% of its NAV next month. Lord Abbett Small Cap Value (LRSCX), where Tom Maher and Justin Maurer took over on Oct. 1, could hand out distributions amounting to 20% to 24% of NAV.

BlackRock has remade several of its equity funds in the past year or so, too, with many of them due to issue large gains this year. BlackRock Capital Appreciation (MDFGX), where Lawrence Kemp took over at the start of the year, will issue gains of between 13.69% and 14.90% of NAV, but most of it long-term gains. Kemp's team also took over and revamped BlackRock Mid-Cap Growth Equity (BMGAX), which will distribute between 15.65% and 17.41% of NAV. BlackRock's Scientific Active Equity team took over BlackRock Small Cap Growth Equity (CSGEX) in May and transformed it from a bottom-up stock-picker's fund into a broader quant offering that, at least while the transition was underway, traded more often. It will issue a distribution of 28.15% to 29.48% of NAV. BlackRock US Opportunities (BMEAX), which also got new lead managers in 2013, put its potential distribution between 19.73% and 20.62% of NAV, and about one third of those gains could be short term. Bart Geer came over from Putnam Investments late in 2012 to run BlackRock Basic Value (MDBAX), but has reaped enough gains in 2013, his first full year at the helm here, to make an estimated distribution of between 12.19% and 13.41% of NAV.

Three T. Rowe Price funds which saw abrupt manager changes in the past year will issue the biggest gains in percentage terms at that family. T. Rowe Price New America Growth (PRWAX), where Dan Martino took over for longtime manager Joe Milano when Milano struck out on his own in May, will make a relatively big distribution--nearly 10% of NAV. T. Rowe Price Media & Telecommunications (PRMTX), where Paul Greene took over for the promoted Martino, will make a distribution of nearly 7.8% of NAV, and T. Rowe Price Health Sciences (PRHSX), where Taymour Tamaddon took over when longtime manager Kris Jenner left the firm in February, will issue gains amounting to more than 5% of NAV.

Douglas Rao took the helm of Janus Forty (JACTX) at the end of May 2013 from the departing Ron Sachs. While Rao only jettisoned three names from the compact portfolio by the end of June, he added eight new holdings and thus needed to adjust the weightings of a number of others. Combine those changes with the fund's mid-20% gains in both 2012 and in 2013 through Nov. 19 and with $1 billion in net outflows in the first 10 months of 2013, and it's not surprising that the fund estimates it will make a capital gains distribution equal to 16.3% of its NAV to those who own the fund in a taxable account as of Dec. 16.

Janus Venture (JAVTX) also got a new manager in May, as Jonathan Coleman took over when Chad Meade and Brian Schaub left the firm after a very successful tenure. Outflows have been fairly modest; $440 million was pulled out in July and August after their departure (flows stabilized in September). But the fund has been on a tear, gaining 17% in 2012 and another 33% in 2013 through Nov. 19. Also, Coleman sold six stocks and added 18 to the fund during late May and June, leading to numerous position adjust­ments. Janus estimates the fund will distribute gains equal to 13.6% of its NAV to fundholders in taxable accounts as of Dec. 16.

Paid in Full
The team that left Janus Triton (JATTX) (as well as the aforementioned Janus Venture) took over Meridian Growth (MERDX) in September. The managers' last Janus Triton portfolio had 12 names in common with Meridian Growth. The fund on Nov. 14 paid out a $13.23 per share capital gains distribution, roughly 27% of its October-end NAV.

The closed Longleaf Partners Small-Cap (LLSCX) distributed $4.91 per share in capital gains, or about 14% of net asset value, on Nov. 7. Longleaf has said small caps look pricey, and it's finding more to sell than buy. Hence the payout.

The estimates of yet-to-be-paid distributions issued by fund companies could change in the next few weeks, so check with your fund companies. If you are considering investing in a fund this fall, be sure you're not buying a big distribution. Capital gains taxes are one of the prices investors pay for strong performance, but make sure you've invested in that fund long enough to have benefited from that performance before accepting and paying taxes on a distribution.

Dan Culloton and Greg Carlson do not own shares in any of the securities mentioned above.