We all love to hate taxes. Especially when it comes to our investments. This explains why some investors are now busy harvesting losses to offset any prior capital gains. It also explains the growing number of investment products on the market that have a tax spin to them.
The goal of these ‘tax-advantaged’ products is to provide the best of both worlds – strong returns and lower taxes. It’s nice if you can get it, but buyers should shop carefully: the more complex a product becomes, the higher its fee and the more complicated it is to understand.
One of the reasons for the emergence of these products is that mutual funds are at times inequitable when it comes to distributing taxes among unitholders.
As a quick refresher, most equity mutual funds distribute any interest, dividend and realized capital gains income at the end of the calendar year, based on each unitholder’s ownership in the fund at the time of distribution. This means that investors who purchase a fund late in the year after it has had a good run of performance may inherit a tax liability that they didn’t benefit from. Similarly, if the fund has a strong long-term record, it may have unrealized capital gains built up, which could ultimately penalize unitholders who are new to the fund.
But it should be noted that there are times when it works the other way. If a fund is treading through a tough market, it may have some realized capital losses waiting to be used to offset future gains. As well, a number of the fund’s holdings could be in negative territory (trading below their purchase price), meaning that future appreciation will in effect be tax free. New unitholders therefore benefit from inheriting capital losses (realized and unrealized) built up in the fund.
Given the weak markets we’ve seen over the last several quarters, many funds are now in this position. This is particularly true for those newer to the game that haven’t yet had the benefit of a strong market to accumulate some gains. The Steadyhand funds certainly fall into this camp, as do many other offerings.
Investors looking to increase their equity exposure through the mutual fund channel are now in a prime position to benefit from strong future returns and lower taxes, without all the bells and whistles of a more complex product.