Fund tax bite makes Sam an unwanted uncle

Got any aspirin?

Hefty capital gains distributions and a less-than-stellar stock market have made mutual fund investors more mindful of the tax man this year, according to a study recently released by Boston- based Eaton Vance Corp.

More than eight out of 10 investors considered taxes on their mutual funds to be an important when making investment decisions, the nationwide survey of 500 investors found.

Nearly 60% said their awareness of taxes on their investments has picked up over the last year.

“I can’t say that I was all that surprised by the findings,” says Duncan W. Richardson, a senior vice president at Eaton Vance and manager of the $7 billion Eaton Vance Tax-Managed Growth Fund.

“I think for investors new to the market and new to equity funds, it came as a big surprise that they could have distributions in a down year.”

Mr. Richardson says strong, built-up gains that carried over from previous years, high portfolio turnover in a volatile market and general insensitivity to tax considerations among fund managers converged last year to create a “perfect storm.”

It dumped large capital gains distributions on many unsuspecting shareholders.

Last year, the average diversified stock fund paid 7.65% of its assets in capital gains taxes, up from 6.42% in 1999, according to Morningstar Inc., the Chicago fund tracker.

disclosure stressed

After a year like that, no wonder taxes were on the minds of many investors.

“I’ve got a few clients who pay attention to their 1099s, and they have raised the tax issue recently,” says Stephen T. Gorman, president of Gorman Financial Management in Hingham, Mass. “Fortunately, most of my clients weren’t hit too badly.”

The survey, conducted by Penn Schoen & Berland Associates Inc. in Washington, also found that 82% of investors considered the disclosure of tax implications on their mutual funds to be important, with 85% saying they carefully examine their statements to determine the degree to which taxes affect their returns.

Giving credence to the Securities and Exchange Commission’s new after-tax return disclosure requirement, 60% of investors polled by Eaton Vance said the U.S. government should force fund companies to show after-tax returns for stock funds.

The SEC’s new rule was passed in January but does not go into effect until the first quarter of 2002. About one-third of the survey’s respondents were aware of the new rule.

Even though investors have professed an interest in tax considerations, the study found that one in four investors did not know their current federal income tax bracket.

Twenty-six percent were unfamiliar with “tax-efficient” investing, and 33% were unable to name an investment that offers high tax efficiency.

“That’s a great opportunity for us,” says Mr. Richardson, whose company specializes in tax-efficient investing. “But it’s also a great opportunity for financial advisers to begin to educate their clients on the importance of taxes on investing.”

While the majority of investors were unfamiliar with the concept of tax-efficient investing, the education process had apparently begun.

In 1999, only 12% of investors correctly associated tax efficiency with minimizing the difference between returns before and after taxes.

The study also found that recent stock market volatility had prompted only 15% of survey respondents to change the amount of money they put into mutual funds, with 36% of them making changes to increase their investments, and 59% making changes to decrease them.

One in five of those surveyed predicted that technology would be the best-performing sector this year. But 38% thought it will be the worst-performing sector.

Energy and pharmaceuticals were tied for second-best bets, with each garnering 8% of the votes. Automotive and utilities, with each sector grabbing 5% of the votes, were tied for the second-worst sector to invest in.

“When asked about different market sectors, the investment area that elicited by far the strongest sentiment – for better or worse – was technology,” Mr. Richardson says. “Love or hate the sector in the short term, it is clearly one that the public feels will continue to be a major market force to be reckoned with.”