It's not what you make; it's what you keep. Here are three funds with great after-tax returns.
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It's not what you make; it's what you keep. Here are three funds with great long-term after-tax returns.
To squeeze every bit of return you can from your mutual funds, stick with those that are both tax-conscious and loaded with winning stockseven if those stocks generate sizable capital gains when they're sold.
With this in mind, we searched the CD-ROM program Morningstar Principia Pro Plus for Mutual Funds for diversified, actively managed stock funds that have superior after-tax returns over recent five- and 10-year periods. We ignored 12-month returns for selection purposes, because the ability to deliver strong returns over time is more important. We also skipped index funds, which are inherently tax-efficient because of their low turnover. Besides solid after-tax returns, all three funds described here have lower-than-average expenses compared with their peers, and each has earned Morningstar's top rating. Just as important, they're affordable: Initial investment minimums are $2,000 or less.
This fund has beaten its benchmarkthe Russell Midcap Growth Indexin each of the past six calendar years, and the S&P 500 over the past three. In addition, its total returns place the fund in the top 1 percent of mid-cap growth funds over three, five, and 10 years, according to Morningstar.*
Following the fund's 78 percent return in 1999, assets ballooned from $102 million to more than $1.2 billion. Normally, such a flood of new money can be problematic, if it comes in faster than the fund managers can find good stocks. However, the CalamosesJohn P. Sr., his son, John Jr., and nephew, Nickcontinue to discover stocks they're excited about. Fortune Brands is one of these companies, whose product line includes leading brands such as Moen faucets, Jim Beam bourbon, and Titleist golf balls. The stock is up 16 percent since the fund first purchased it in February. "The company has been aggressively reducing its debt and improving its balance sheet," says Nick Calamos.
Stocks in the Calamos Growth portfolio are balanced over multiple business sectors; the fund isn't nearly as top-heavy as it was as recently as 1999, when 55 percent of its assets were invested in technology. Today, tech accounts for around 16 percent of assets, which isn't much more than the fund's retail-sector allocation.
Because the managers sell stocks as soon as they show signs of deterioration or meet pre-set price targets, the fund's turnover rate is 91 percent, which seems high for a fund that's considered tax-efficient. However, the Calamoses use several strategies to limit their shareholders' capital gains liability: They sell their highest-cost shares first (thereby lessening net gains); offset profits on their winners by selling their losers to claim the losses; and generally avoid companies that pay high dividends.
"Moreover, the team's focus on a company's financial strength has helped the fund avoid disasters," says William Harding, a Morningstar analyst. "Calamos got its start as a shop centered on convertible securities, so its analysis has always keyed on a firm's balance sheet and cash flows." (Convertibles are generally preferred shares of corporate securities that can later be exchanged for a set number of common shares at a prestated price.)
Clearly, the Calamoses know a thing or two about evaluating companies: Calamos Growth's annualized after-tax return for the past 10 years is 14.9 percent. That ranks it first among its mid-cap peers. "The fund's ability to deliver good relative returns in a variety of market climates sets it apart from the competition," Harding says.
Combine smart stock picking with low turnover and low expenses and you get Muhlenkamp Fundwhich, as you might expect, also gets high marks for after-tax return and tax efficiency. Remarkably, the $744 million fund has had only one negative return in the past 10 calendar years (-7.2 percent pre-tax, in 1994).
Unlike the Calamoses, who happily pay fair value for a stock's growth potential, fund manager Ron Muhlenkamp searches for bargains. For instance, rather than purchase The Home Depot, which he considers overpriced, Muhlenkamp owns a small-company stock, American Woodmark. It supplies cabinetry to Home Depot but is valued more reasonably, in his opinion.
Muhlenkamp doesn't avoid large-cap companies altogether, especially those that have been beaten down. He currently owns positions in financial giants Citigroup, Merrill Lynch, and Morgan Stanley, each of which is down more than 25 percent this year.
"These are still three very good companies," says Muhlenkamp, adding that the financial-services business is highly cyclical. "Citigroup is trading at just 11 times earnings." That's less than half the price-earnings ratio of the typical stock in the S&P 500a potential bargain, indeed.
Another company Muhlenkamp considers ripe for a turnaround is Calpine, a $1.5 billion outfit that owns and operates electrical- and thermal-energy plants in the US and Canada. Calpine's stock price has gotten battered over the past 12 months, sinking 86 percent, in part because of the bad investment climate the Enron situation created for energy companies. But as investors headed for the exits, Muhlenkamp added more shares, making his fund one of the largest stockholders in the company. Calpine shares now make up 4 percent of the fund's assets.
"Calpine built several power plants a few years ago that are much more efficient than older plants," he says. "When the economy rebounds, demand for electricity will increase, and it'll get a boost in years with hot summers and cold winters. Unless consumers and businesses sharply curtail their use of electricity, which I don't expect will happen, Calpine will do well over the next few years." The company has also acquired a Canadian natural gas company, which will help reduce its costs to produce electricity.
In addition to being a value investor, Ron Muhlenkamp is a buy-and-hold guy, as evidenced by his portfolio's puny 11 percent turnover rate. (The number is a rough indication of what percentage of the portfolio's holdings changed over the past year.) Only about 6 percent of actively managed stock funds have a rate that low or lower, according to data from Morningstar Principia. Muhlenkamp says the fund has made just five capital gains distributions to shareholders since its inception 14 years ago. It has owned shares of Citigroup and Merrill Lynch, for instance, since the early 1990s. "When you get good companies at good prices, you don't have to be quick to sell them," he says. "You can hold them long enough to lower your tax bill."
Albany International, Arkansas Best, Brown Shoe, Hughes Supply, Nu Skin Enterprises, Veeco Instruments. Never heard of these companies? Then welcome to the world of micro-caps, where today's tiny firm could become the future's multibillion-dollar corporation.
One person who's making sense out of this worldand rewarding patient investors in the processis the portfolio manager of Royce Opportunity Fund, Boniface "Buzz" A. Zaino. A former principal with Lehman Brothers, Zaino has 25 years' experience as a portfolio manager trading in small-cap and micro-cap value stocks. A "micro-cap," as defined by Morningstar, is a company worth roughly $400 million or less.
"Buzz Zaino has a knack for selecting good-quality small stocks that are cheaply priced," says Lewis J. Altfest, a New York financial planner who worked with Zaino at Lehman Brothers. "We've been recommending his fund to our clients for several years." It has returned 18.3 percent a year since (pre-tax) its inception in November 1996.
Zaino's record is even more impressive when you consider that Royce Opportunity owns roughly 280 stocks, or about 100 more than the typical small-cap value fund. The large number of stocks helps to keep the fund well-diversified, but it also means Zaino must search harder for bargains. "One area we're looking at now is DSL [Digital Subscriber Line] providers," he says. "Statistics continue to be very positive on the rate of DSL installation, both in the US and overseas." Providers of DSL use existing copper telephone wiring to allow high-speed Internet connections.
"We're also beginning to nibble at some semiconductor manufacturers," Zaino says. "Interestingly, the intrinsic value of these companies is higher than their stock prices and the current business climate would suggest." Royce Opportunity's five-year annualized return places it in the top 2 percent of all domestic-stock funds. Be warned, however, that investing in micro-capswhich have at times made up as much as 73 percent of this fund's total holdingscan be a wild ride. So if you can't stomach a great deal of volatility in your investments, you'd better pass on Royce Opportunity. But if you're young, willing to take a lot of risk, or both, then hop onboard and fasten your seatbelt.
*Unless otherwise indicated, all returns mentioned in the text are pre-tax and are through July 31, 2002.
For years, mutual fund companies conveniently ignored telling investors about their funds' after-tax returns. No longer. Beginning this year, the Securities and Exchange Commission requires all fund companies to report both pre-tax and after-tax returns in their prospectuses. Here are three funds that hold their own in either light.
|Tax-adjusted total return*|
|1 year||5 years (annualized)||10 years (annualized)||Category average (10 years)||Category|
|Calamos Growth||-17.5%||14.5%||14.9%||5.3%||Mid-cap growth|
|Royce Opportunity||-14.4||9.9||N.A.||9.4||Small-cap value|
N.A.: not applicable.
Funds have no loads, except for Calamos Growth, which charges 4.75 percent on investments of up to $50,000 and smaller loads on larger amounts.
*Excludes capital gains that would result from selling fund shares at the end of the period. Assumes 38.6 percent federal tax on all income and short-term capital gains distributions, 20 percent tax on long-term gains, and reinvestment of dividends. Ignores state and local taxes. All figures are through July 31, 2002.
Contact information: Calamos Growth 800-823-7386; Muhlenkamp 800-860-3863; Royce Opportunity 800-221-4268.
Dennis Murray. The best measure of a mutual fund.