Buy Our Fund! It Has Massive Losses!

Tax-focused marketing pitches for some fund companies border on the bizarre.
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Fund marketers don't have boffo gains to boast of anymore, so now they're touting their growth funds' losses.

In a sign of the dreary times,

RS Funds

spotlights the inordinately high losses booked by six of its stock funds in a

posting on the firm's Web site. The announcement touts the "large tax-loss benefits" these funds offer to those buying shares now. The pitch is that having all these losses on the books will help fund managers offset future capital gains and avoid taxable distributions down the road. But the underlying takeaway is that in the wake of the

Nasdaq

bubble, the fund world's sales pitch isn't just about how much you can make but also how much you've already lost.

"It's certainly a new approach," says Scott Cooley, a senior fund analyst with Chicago fund tracker Morningstar. "I think it's a recognition of the fact that no one is going to buy these funds based on recent returns, so there has to be some other angle. My suspicion is that it took them a while to come up with this. Frankly, it's admitting, 'We've already lost a lot of investors' money.'"

The red-stained funds include the

(RSEGX) - Get Report

RS Emerging Growth fund, which

earned manager Jim Callinan Morningstar Manager of the Year honors in 1999. An RS Funds spokeswoman didn't return a call seeking comment Monday.

Here's how funds and capital gains distributions work: When your fund's stock and bond sales lead to more profits than losses, it has to pay those excess gains to you. If you own the fund in a tax-deferred account such as a 401(k) or an individual retirement account, you don't owe any taxes until you withdraw your money. But if you own the fund in a standard account, you usually have to pay 20% of that money to unsmiling Uncle Sam, even if you hang on to your fund shares. That could make a lousy year downright miserable, as it did last year, when 1999's gains led to record distributions even though most funds were in the red.

That debacle made fund investors more aware of tax implications, but stocks' continued losing streak should make distributions rare and modest this year. After all, the Nasdaq Composite and

S&P 500

are down 44% and 18%, respectively, over the past two years, according to Baseline/Thomson Financial.

The average large-cap growth fund has lost a quarter of its value over the past 12 months, worse than any calendar-year loss over the past 30 years. So, highlighting potential tax advantages makes more sense than highlighting recent performance. Just two of the RS Funds highlighted in the announcement trail their average peer over the past year, but the past year's losses have made fund investors skittish.

And who could blame them? The

(RIAFX)

RS Internet fund has a share price of $9.48 but had booked a whopping $18.15 in losses per share on Oct. 31. And the RS Emerging Growth fund, down some 33% over the past year, has a $29.31 share price and more than $17 per share in realized losses.

Tax-focused pitches like these will be helpful for many investors, who have often focused solely on funds' returns, rather than how much of those gains ended up in the government's pocket. Announcements like these and new requirements for fund companies to disclose their funds' after-tax returns will make at least some investors more tax-conscious.

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That said, tax issues shouldn't be the sole driver of your interest in a fund. There is an ocean of ravaged growth funds out there with huge losses on their books. Many of these funds made outsize and ill-timed bets on the tech sector, and buying them simply for their losses would be as foolish as buying them simply for their past gains last year.

Morningstar's Cooley recalls a recent shareholder report for the

(JAMFX) - Get Report

Ryan Jacob Internet fund that listed some $188 million in realized losses and just $17 million in assets. The fund is down 67% over the past 12 months and seems doomed for liquidation.

The bottom line is that these actively managed funds' tax-loss pitch and past year's drubbing prove the rationality of committing the lion's share of your portfolio to diversified, tax-efficient and cheap index funds.

Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

imcdonald@thestreet.com, but he cannot give specific financial advice.