Someone forwarded to me an email from a local accountant who was warning his clients who own mutual funds about large capital gains distributions that funds will be required to make at the end of this year because of record redemptions of units during the recent market slide.
I’m not sure why the redemptions as such would necessarily give rise to large gains inside the funds that must be allocated to unitholders. It is true that, to meet redemptions, funds must sell securities, but many funds turn over their portfolios so frequently that it seems unlikely that they would have huge gains that would be realized because of redemptions. Moreover, any such gains would likely be offset at least partially by losses, especially in this market.
The cautious investor, however, can call a fund company to obtain an estimate of the distributions that will be made by a fund at the year-end. These estimates are prepared annually, and apparently they are ready at about this time of year.
There very well could be large gains this year as 2008 was a record year for growth. The distributions are paid out either monthly or with an annual amount about December 15th…but this would not be due to redemption as the consumer redemptions most likely happened as the market fell. The gains are pushed through to the unit holder regardless. The only way that the gains will be “offset by the losses” is if the unit holder crystalizes their losses by selling thier equity mutual fund for 31 days. The mutual funds do not push the losses through, only the gains and dividends. Also when the gains are distributed at year end, the unit value drops.
Mutual fund trusts are not true flow-throughs for tax purposes, unlike partnerships. Nonetheless, losses realized by such a trust can be used to offset gains in the trust, and to the extent that such losses eliminate gains, a trust need not distribute net gains to unitholders. It would seem that, during the worst market decline in recent history, trusts should have losses they can use to offset gains. In particular, they should realize losses as they sell securities in a falling market to meet redemption requests.
That said, I am speculating, and anyone concerned about the prospect of large net gain distributions should call his or her fund company to find out what the expected distributions will be.