With another 75 basis points added to the Federal Funds Rate in September, expectations of an impending recession have been even further validated. Major indices, equity and fixed income alike, have plummeted and set new lows for the year in September as well.
As more and more fund holders opt to sell, fund managers are in turn forced to sell their holdings to meet redemptions. The vicious cycle continues and usually leads to larger than usual capital gains distributions compared to years past. For many advisors, minimizing tax implications for their clients is again a top priority.
As a wholesaler, this is an opportunity for you to develop relationships with your advisor-partners. How can you help limit distributions and their tax side-effects for the advisors you work with?
With YCharts, wholesalers can quickly identify funds that are likely to have large capital gains distributions, then protect their advisor-partners from those distributions by recommending suitable replacement funds.
(Disclosure: you should always check a fund manager’s website for tax information pertinent to their funds and investors.)
Until they are actually distributed, it’s difficult to know the exact value of any long or short-term capital gains that will be passed on to a fund’s investors. That said, data and technology can help you find funds that are likely to have the largest distributions to investors.
We’ll use the metrics below to identify those funds:
Potential Capital Gain—an estimated percentage of a fund’s assets that may be distributed as future capital gains; this metric is an estimate and is provided by Morningstar® Distribution Yield—the percentage of the current share price that an investor received as distributions, including dividends and capital gains, over the past 12 months Tax Cost Ratio — the amount that a fund’s annualized return is reduced by taxes that investors must pay on distributions (including stock and bond dividends and capital gains distributions); also known as tax efficiency Turnover Ratio — the percentage of a fund’s holdings that have been replaced over the past twelve-month period
Preparing for Your End-of-Year Meetings
The objective of this exercise is to identify funds that are likely to pay out large distributions, note which advisors are using those funds, position your funds as suitable alternatives, and ensure advisors avoid investing in a fund with an impending distribution.
Starting in the Fund Screener, add a few filters that will narrow our universe to a more manageable list of funds that are ripe for replacement.
Per the example below, screen for funds in the Large Blend category with over $500 million in total AUM and Potential Capital Gains over 20% of the fund’s NAV.
Exclude all index funds as their benchmark-tracking nature means they perpetually carry unrealized gains and should not be considered as part of this exercise.
When working with a specific advisor-partner, add a filter for Brokerage Availability to limit the Fund Screener results to only those funds that the advisor can access.
For example, if you are working with an advisor at Morgan Stanley, you could filter to show only funds on the Morgan Stanley Select UMA platform. Similarly, you can pull up competitor funds to see where they may be exposed.
Next, add Potential Capital Gain, Distribution Yield, Turnover Ratio, and Tax Cost Ratios for several durations using the “+ Metrics Columns” button to capture as much historical information as possible. In combination, these metrics paint a complete picture of each fund’s tax efficiency.
To avoid relying on a single metric when evaluating replacement opportunities, use Scoring Models to combine all of the metrics and create a single, numerical ranking to aid in your decision-making.
According to the score outlined below, funds that rank at or near number one are the least tax-efficient, and thus the best opportunities for replacement.
The Scoring Model above ranks each metric equally at 10%. However, you can add more or less weight to any chosen metric based on importance so long as all weights add up to 100%.
Once the Scoring Model is added to the fund screen, sort the results by their scores and dig into the highest-ranking funds, which are the least tax-efficient, for potential replacement opportunities.
Digging Deeper Into the Best Opportunities
The goal of this workflow is to hone in on a specific fund and its historical metrics to create an optimized strategy to avoid large distributions.
The Fund Screen and Scoring Model showed that one of the least tax-efficient funds on our list is the JPMorgan US Large Cap Core Plus I fund (JLPSX).
Of note, JLPSX has turned over more than 59% of its assets in the last year, and its distribution yield is 36.85% for the same period.
From the JPMorgan US Large Cap Core Plus I fund quote page, shown below, click on the “Data” tab then type “dividend” in the metric field to see all historical distributions. In December 2021, the fund distributed long-term capital gains of $6.40 per share and brought the fund’s net asset value down from $30.83 to about $23.67 — your advisor partners could have used a tip-off!
Whether you’re prepping for a meeting with an advisor or in the middle of a conversation with a prospect, YCharts ensures you have all of this information available for you to pull up on the fly.
Viewing distributions by value and date also provides an opportunity to look for patterns. It appears that JLPSX has issued distributions between December 11th to the 13th dating back to 2017. For advisors looking to avoid this year’s distributions, December 10th or earlier should be the target date to escape unscathed.
Aligning Interests with Advisor-Partners
With so much money in motion as we head into the end of the year, wholesalers and financial advisors can align their interests around optimizing tax efficiencies.
By leveraging YCharts’ powerful tools and data, wholesalers can make data-driven recommendations that help their advisor-partners avoid distributions and protect their clients’ investments.
Data, and the ability to easily access and analyze data, are vital resources for asset managers who want to position themselves and their funds for success. With YCharts, wholesalers can identify the right funds for the right advisors at the right time, building trust and gathering assets along the way.
Learn more about how you can make better tax-efficient recommendations for your advisors-clients: