Last month we purchased Fidelity Limited Term Bond (FJRLX) in our model portfolio. Part of our strat...
03/28/2016 9:00 am EST
If you are looking for a tax-efficient fund, you can just rank funds by tax efficiency and be done, right? questions Russel Kinnel, editor of Morningstar FundInvestor.
No, in reality, tax efficiency isn’t all that helpful. You can put money in shoeboxes in your closet and have great tax efficiency. What you really want is after-tax returns.
To find funds with a good chance of outperforming on an after-tax basis, I screened for Morningstar Medalist funds with below-average expense ratios; net inflows; and potential capital gains exposure (PGCE), below 25%.
I also screened for 10-year after-tax returns that rank in the top third of their Morningstar Category; and turnover below 50%.
Put all that together, and you have a much better formula than tax efficiency. I screened for inflows because outflows can lead to larger capital gains distributions than you’d expect from returns alone.
Conversely, sizable inflows can water down tax bills for shareholders. PCGE tells you the amount of built- up gains a fund has.
Here, then, are four funds that look like good bets and which passed all my screens:
T. Rowe Price QM US Small-Cap Growth Equity (PRDSX)
This fund’s newfound popularity means it has had lots of inflows to water down gains. It has only a 7% PCGE.
To be sure, you wouldn’t want the fund to grow so big that it has to alter its strategy, but, as the name says, it is diversified.
Sudhir Nanda’s quantitative models have run circles around the competition since he took over in 2006.
PRIMECAP Odyssey Growth (POGRX)
Of course I will plug a Primecap fund whenever I can. It runs outstanding funds, including this excellent large-growth fund.
The fund is low-cost, low-turnover, and high-integrity. Our analyst David Kathman sums it up nicely as patient contrarian growth.
The strategy will have its off years (it has started 2016 in a hole), but its investment chops show up in the long run.
Vanguard Equity-Income (VEIPX)
Like a number of Vanguard funds, this one is dull but effective. The fund’s two sub advisors run a diversified portfolio of dividend-paying stocks.
Michael Reckmeyer of Wellington and a trio of managers from Vanguard’s quant group run the portfolio.
With a low expense ratio of 0.26%, the fund has built a top-decile record during the past five-, 10-, and 15-year periods, and it looks even better on an after-tax basis.
Fidelity Tax-Free Bond (FTABX)
If you are building up a portfolio in a taxable account, munis make a lot of sense. Even after a recent run of outperformance versus taxable bonds, they still are pretty attractive when you factor in taxes.
Jamie Pagliocco runs the fund to the cautious side of the market, so he sacrifices a bit of yield for better downside protection.
The fund doesn’t buy bonds subject to the Alternative Minimum Tax, so it is a good idea if you are in AMT territory.
By Russel Kinnel, Editor of Morningstar FundInvestor
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