Dear Dagen: Taxable Distributions Dwarf Returns at Oakmark

When a fund manager shows a blatant disregard for tax issues, he deserves to be put under the hot lights.

Last week, this column highlighted the (KAUFX Quote)Kaufmann fund's large capital-gains distribution.

It turns out that there are plenty of other funds that should be dragged out into the open and put to shame.

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The (OAKMX Quote)Oakmark fund sits on top of the heap.

Last week, this widely known value fund, managed by Robert Sanborn, made a distribution of $4.996 a share, which represents 15% of its net asset value before the distribution was made.

The ever-popular (OAKLX Quote)Oakmark Select fund, managed by Bill Nygren, made a distribution of $3.913 a share, almost 18% of the fund's net asset value. (These distributions are comprised of primarily long-term gains, which are taxed at a lower rate than short-term gains.) Anything more than 15% is considered excessive.

All mutual funds are required to distribute net realized gains to shareholders each year. The distributions usually happen during the holiday season.

Obviously, some fund managers are sensitive to the taxes that they pass along to their shareholders, while others are known for giving investors a good belt year after year.

Links to Mutual Fund Distribution Information Do you know of others? Let us know.
Acorn
Alleghany
American Century
American Funds
Amerindo
Babson
Berger
Buffalo Funds
Dreyfus
Fidelity
Fremont
Gabelli
Guinness Flight
Harbor
Invesco
Janus
Kaufmann
Kemper
Legg Mason
Lexington
MFS
Montgomery Asset Management
Neuberger Berman
Oak Associates
Oakmark
PBHG
Putnam
Royce
RS Investment Management
Safeco
Stein Roe
Strong
T. Rowe Price
Vanguard
Van Wagoner
Westcore
Source: Mutual fund companies

Sanborn's Oakmark might very well be turning into one of these sadists.

Last year, for example, Oakmark made a surprise distribution in August. At the time, Oakmark's distribution was 10% of its NAV, not quite as fat as its one this year.

At least last year the Oakmark fund was up a tiny 3.7%. This year, the fund is down 7.7%, making its large distribution even more appalling.

Of course, if a fund is producing outsize returns, shareholders will likely be less concerned with a large distribution.

Take the case of the (FUSMX Quote)Fremont U.S. Micro-Cap fund.

In late October, the fund made a short-term capital-gains distribution of $5.74 per share, or almost 18% of its NAV before the payout.

However, this micro-cap fund has produced some fantastic returns this year, up 91.1% for the year to date.

In fact, shareholders shouldn't be too surprised by the size of this distribution. The Fremont fund's turnover was 170% last year. Heavy turnover is one of the few clues you can look for to see if a fund might have a large distribution. Consistently high turnover means that a manager is prone to frequent trading in the portfolio, which potentially generates tax liabilities for shareholders.

Small-cap and aggressive-growth funds are more apt to distribute short-term gains and deserve close attention if you are concerned about tax consequences. In December, the (PRSCX Quote)T. Rowe Price Science & Technology fund is expected to make a combined long- and short-term distribution of $11.38 per share, according to the firm's estimates. That's currently almost 18% of the fund's NAV, and the distribution could wind up being a couple of dollars more.

The other major signal for a possible distribution: redemptions.

If a fund is experiencing heavy shareholder selling during the year, the manager could be forced to sell stock to meet these redemptions. If you witness a noticeable drop in a fund's assets, which doesn't seem to correspond with its performance, you might want to brace yourself for a big capital-gains distribution or even get out before it is made.

Redemptions have plagued both the Oakmark and Kaufmann funds this year. During the first six months of this year, Oakmark lost $2 billion in assets to net redemptions, according to Financial Research Corp. in Boston. Kaufmann lost $1.4 billion in net redemptions this year through September.

In fact, Oakmark blames this year's high distribution on redemptions.

In a statement, the firm says, "Under normal circumstances, the fund would only sell stock in order to obtain cash to reinvest in more stock to make money for its shareholders. This year, however, the fund was forced to sell stock in order to generate cash to cover an unusually large amount of redemptions from the fund. The fund does not expect this latter circumstance to occur very often."

Of course, you shouldn't buy or sell a fund based solely on its taxable distributions every year.

However, if you're getting hit year after year without the benefit of decent returns, this may be another good reason for you to sell.

Parting Words for Kaufmann

Kaufmann's recent distribution made some former shareholders gleeful that they dumped this fund when they did.

"I was sucked in by their advertising but have been out for two years," writes Kevin Boyle. "This is one turkey that shouldn't make it to Thanksgiving."

Others aren't so lucky.

"I have watched this fund languish through two or three years of soaring markets. I have owned the fund for six years and cashed on Monday, Nov. 15. I still don't know why I waited," writes David Tentilucci.

Better late than ...

Never mind.

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