WASHINGTON PRESSURE BUILDS ON FUNDS TO ADVERTISE AFTER-TAX-BITE RETURNS: PRE-TAX FIGURES MERELY HOT AIR, BACKERS SAY

Congress and the Securities and Exchange Commission are looking at ways to spur mutual funds to give investors a clear idea of their after-tax returns, an effort that is being closely watched by many financial planners.

For the second time in two years, Rep. Paul Gillmor, R-Ohio, has introduced legislation that would require the SEC to issue regulations improving disclosure of portfolio turnover on mutual fund returns.

Rep. Gillmor says his legislation, which is co-sponsored by Michael Oxley, R-Ohio, chairman of the House Commerce subcommittee on finance, and that panel’s ranking minority member, Edward Markey, D-Mass., has a good chance of passage this year, either as separate legislation or attached to another bill.

“The difference between the after-tax and pre-tax return is a huge number in terms of what an investor will actually receive from their investment,” Rep. Gillmor says, adding that there typically is a 3% annual difference in the returns. “When you look at a newspaper and see all these wonderful charts, none of those charts show what an investor’s real return would be.”

He notes that the mutual fund industry already has the information, which they must report to shareholders each year for tax returns. “Nobody has to create any new information. It’s all there.”

levitt likes it

Rep. Gillmor also says he has spoken to SEC Chairman Arthur Levitt about the bill. “He indicated to me he was very favorably disposed to it.”

An SEC spokesman, Christopher Ullman, says Mr. Levitt would not take a position on the legislation unless asked to comment by Congress.

Differences can be major. Chicago-based Morningstar Inc., one of the few companies to attempt to compute after-tax returns for mutual funds, lists Alger Capital Appreciation Return Fund in the top 10 of all U.S. diversified equity funds for 1998 with a return of 66.95% before federal taxes. In after-tax rankings, however, the fund drops to 31st with only a 39.6% return.

“We are looking at it,” says Susan Nash, senior assistant director in the SEC’s Division of Investment Management, referring to the issue of requiring mutual fund companies to disclose after-tax returns on their prospectuses. It is not clear if the SEC is going to propose new regulations, she adds.

While it’s relatively easy to spell out different returns for different tax brackets, challenges include deciding what assumptions should be used in calculating the cost basis for a fund, whether redemptions had been taken, and whether to change calculations as tax laws change. “You’re talking about adjusting a number that may have been earned 10 years back,” Ms. Nash says.

Advisers disagree as to whether such reporting would be useful.

Robert Levitt, principal adviser at Levitt Novakoff & Co. LLC, a Boca Raton, Fla., firm that supervises $100 million, says Morningstar’s after-tax information “has no value. It takes a return and subtracts hypothetically what you’d pay in taxes. If you had an unrealized gain, they don’t charge it to the return. You have to pay the tax at some point. Most people are forgetting that you’re building up an unrealized return.”

But Lee Price, managing director of Dresdner RCM Global Investors, a San Francisco investment adviser that manages $62 billion, concluded after studying the issue that such a method is the best way to show after-tax results. Mr. Price headed a committee put together by the Association for Investment Management and Research in Charlottesville, Va., which represents the investment community.

The committee in 1994 issued a study setting standards for reporting after-tax results for funds and separate accounts. While the method the committee selected is more complicated than others proposed, he says it is the most accurate method. The AIMR-approved method would require that taxes be subtracted from returns whenever a taxable event occurs.

The method is more complicated than assuming all gains are taken. “For each sale or accrual of income, the manager has to know what taxes are due,” he notes. “(For example) Treasury bonds only pay federal taxes, different bonds may pay state and federal taxes. You must know the cost basis for the sale of stock.”

dresdner comes on board

While his company does not report returns on an after-tax basis, Mr. Price agrees with Rep. Gillmor’s proposal. “Individuals who are the main purchasers of mutual funds should be aware of the after-tax returns, not just the pre-tax returns.”

More mutual fund companies are starting tax-managed funds for investors with taxable investments. Mutual funds in individual retirement accounts, 401(k)s or other tax-deferred accounts do not have to pay taxes until the money is withdrawn.

Terry Banet, manager of J.P. Morgan & Co. Inc.’s Tax Aware U.S. Equity Fund, noted that there are close to 50 such funds now, compared to just seven when hers was begun two years ago. The fund earned a 30.89% after-tax return last year, compared to a pre-tax return of 28.58% for the S&P 500.

“I think it’s actually a pretty reasonable idea,” Ms. Banet says of the proposal. “It will segregate people out more into taxable and tax-exempt people, so it might help out the tax-managed funds even more with attention.”