Anatomy Of A Mutual Fund Tax Land Mine

November 25, 2014

Why one mutual fund is headed for a monster tax problem.

Yesterday the Wall St. Journal reported on a handful of mutual funds expected to have a particularly hard time with capital gains this year. The poster child for the unfairness of the mutual fund taxation system may end up being the Neuberger Berman Large Cap Disciplined Growth Fund. Here's the crucial passage from the article:

"One fund planning a whopping distribution is the $152.4 million Neuberger Berman Large Cap Disciplined Growth fund. Large investors bailed out of the fund this year, which has lagged behind the S&P 500 Index since 2010, forcing it to sell securities that had appreciated greatly over the years. As a result, the fund is expected to pay out more than 50 percent of its net asset value Dec. 16."

That's a claim worth teasing out, and I thought it would make a great example to explain what actually happens in a situation like this.

First, a little bit about this fund—it's a large-cap growth fund that sets its bogey as the Russell 1000 Growth Index. In the fiscal year ended Aug. 31, 2014, it returned anywhere from 12.18 percent to 19.41 percent, depending on which of the seven share classes you held. (Don't you love mutual funds?) Being charitable, even that 19.41 percent was far behind the index, which was up 26.29 percent. That underperformance persists for one, five and even 10 years and since inception.

In other words, it's just not a very good fund. And to make matters worse, the guy running it just retired, and a new guy, John Barker, took over the reins in August.

Jumping Ship

So what did people do in 2014? They took money out. And when they took their money out, they forced the fund to sell securities. Because the fund has generally had a positive run—by that I mean it's not losing money even though it didn't beat its benchmark—most of its positions are held at implied gains. By selling, the fund booked those gains.

How many people sold? Through the fiscal year ended Aug. 31, the fund had $251 million in redemptions, following $270 million in redemptions the year prior.

Here's the problem. First off, if Bob is somehow convinced this is a good fund, shouldn't someone tell him he's walking into a giant distribution before he buys? If he looks online, he won't find a press release telling him about the monster hit coming his way if he were to buy in right now.

You won't find a banner on the website. You'll have to hunt around for the Tax Documents page and then dig in. Once there, you have to scan through until you find this gem:

Investor Class Shares
2014 Year-End Income and Capital Gain Distributions - Estimates

Fund Ticker Fund
Number
Income
Dividend1
Short-Term
Capital Gain2
Long-Term
Capital Gain3
Total
Focus NBSSX 494 $0.14 - $0.20 $0.45 - $0.51 $3.69 - $3.75 $4.28 - $4.46
Genesis NBGNX 493 $0.06 - $0.12 None $4.74 - $4.80 $4.80 - $4.92
Guardian NGUAX 484 $0.12 - $0.18 $0.06 - $0.12 $2.55 - $2.61 $2.73 - $2.91
International Equity NIQVX 495 $0.12 - $0.18 None None $0.12 - $0.18
Large Cap
Disciplined Growth
NBCIX 1257 $0.14 - $0.20 $0.55 - $0.61 $3.73 - $3.79 $4.42 - $4.60

 

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