VANGUARD AFTER-TAX REPORT PLAN ADDS FUEL TO TAX-MANAGED FIRE: MORE INVESTORS DODGE CAPITAL GAINS LEVIES

Vanguard Group’s decision to become the first fund company to publish after-tax returns for stock and balanced portfolios comes at a time when investors are growing ever more leery of Uncle Sam’s bite.

Tax-managed funds, which aim to maximize after-tax gains rather than gross returns, had 1999 net sales of $4.6 billion through August. That compares to $4.1 billion for the first eight months of 1998 and to $2.3 billion for all of 1997. Assets in tax-efficient funds stood at $20.7 billion on Aug. 31, up from $15 billion and $6.9 billion at the end of 1998 and 1997, respectively, according to mutual fund consultancy Financial Research Corp. of Boston.

“Investors are becoming much more tax conscious,” says Mike Evans, an analyst at FRC. “That’s being spurred, in part, by the tremendous returns many of them have experienced in recent years.”

Just before Malvern, Pa.-based Vanguard’s announcement, Putnam Investments launched the first of what is expected to be a family of tax-savvy funds, the Putnam Tax-Smart Equity Fund. The large-cap fund will be managed by a team led by Robert R. Beck, who is co-manager of the Voyager Fund.

pioneer on trail

In September, Pioneer Group Inc. of Boston filed a registration statement with the Securities and Exchange Commission to launch a tax-savvy fund, the Pioneer Tax Managed Fund.

“We think this market is going to explode,” says Howard Present, managing director and head of product management and development at Boston-based Putnam.

Mr. Present says Putnam has been eying the tax-managed category for several years, and that the Tax Smart Equity Fund had been in development for about 18 months.

Putnam hopes to distinguish its offering from the 45 or so other tax-managed funds by making it a point to limit unrealized capital gains -paper profits on investments – to 15% to 25% of the fund’s net assets. When funds sell their appreciated stocks, they must pass along the gains to investors, who, in turn, pay taxes on them.

Once the capital gains get too high, Putnam plans to close the fund and open a new one with the same investment philosophy. The idea is to reduce the tax penalty to new investors, which normally pay taxes on funds even though they do not get the benefit of the funds’ previous performance.

Putnam, like others in the tax-managed field, is also managing the portfolio so that groups of the same stock will be handled individually, depending upon the purchase price. That way, says Mr. Present, the fund’s managers can sell the most expensive group first and harvest a greater capital loss. Most fund companies lump the stock together and calculate the capital losses based on an average purchase price.

first, the returns

“Many of our competitors manage their funds with the No. 1 priority being no capital gains distributions,” Mr. Present says. “The problem is that to have high after-tax returns, you have to have high pre-tax returns.”

Many of these funds have fared well. For instance, the $5 billion-asset Eaton Vance Tax Managed Growth Fund was up 29.56% for the 12 months ended Oct. 12, though it lagged the 33.75% return of Standard & Poor’s 500 stock index. For three years it was up an average annual 21.8%, vs. the index’s 25.14%.

“We always expected competition,” says Duncan Richardson, who manages the fund for Boston-based Eaton Vance Corp. “The more fund groups to enter the market, the better it is for everyone.”

Eaton Vance doesn’t have too much to worry about, at least for the time being. With $5.2 billion in assets in its coffers, Eaton Vance controls 25% of the tax-managed market. The other big players are San Francisco’s Charles Schwab Corp., with $6.9 billion, or 33% of the market, and Vanguard with $4.1 billion, or 20%.