Mutual funds made one hot mess out of August.
On Aug. 10, Fidelity Investments conducted stock splits on some of its biggest funds, cutting their per-share prices by a factor of 10 while giving investors 10 times as many shares -- a gesture that leaves shareholders exactly where they were before. On Aug. 22, Harbor Capital Advisors, which runs the $20 billion Harbor International Fund, announced it would pay out between 35% and 42% of the fund’s net asset value as capital gains -- handing many of its investors a giant tax bill. And on Aug. 27, the Securities and Exchange Commission imposed $98 million in sanctions on several firms involved in the Transamerica Tactical Income Fund, alleging that they didn’t properly test that the fund’s strategy would work before launching it.
The main reason for Fidelity’s share split was to “eliminate confusion in the marketplace,” says a Fidelity spokesman, Charlie Keller. “It’s more of an optics thing.” Mutual funds tend to start out at $10 per share, apparently giving some investors the erroneous belief that a fund with a high share price must be overvalued.
Morningstar tracks 20 funds with prices of at least $250 per share. At the Bruce Fund, a $540 million stock-and-bond fund based in Chicago, net asset value this week exceeded $543 per share. Should the fund split to lower its share price? “I wish it was higher!” exclaims co-manager Jeffrey Bruce. In his 35 years at the fund, he says, “maybe one single investor” has ever urged a stock split.
“Would you rather have four quarters or one dollar?” asks Mr. Bruce. “It’s a moot question. We’ve never felt any urge or need to split.”
At Harbor International Fund, two factors triggered that jumbo tax bill.
First, over the 12 months ended July 31, according to Morningstar, investors pulled $12 billion out of Harbor International, the biggest withdrawal from any actively managed fund. That has compelled the fund to sell stocks -- often at a taxable gain -- to cash out the investors who leave.
Second, amid a decline in performance after 2013, Harbor has hired a new manager, Marathon Asset Management LLP, which will sell most of the existing portfolio.
Harbor International’s short-term woes stem from its long-term success. Its founding manager, Hakan Castegren, consistently earned market-beating returns until he died in 2010 -- holding his favorite stocks for years on end.
So the fund bought many of its holdings at a fraction of their current market value. Selling them is triggering a gigantic tax bill.
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As of June 30, taxable investors held about 40% to 45% of the fund’s assets, estimates Charlie McCain, chief executive of Harbor Capital Advisors Inc., which operates the fund.
“This was a very difficult decision for us to make,” says Mr. McCain. “We’re trying to be as transparent as possible.” He says Harbor’s call-center employees are required to warn prospective investors that they will owe a big tax bill if they buy the fund before yearend in a taxable account.
Jeffrey Ptak, an analyst at Morningstar, says Harbor did the best it could in a difficult situation. “But a shareholder who has exhibited just the kind of long-term stick-to-it-iveness that the fund industry says it wants to promote could end up being drenched with a big taxable distribution,” he says. “It doesn’t seem to promote good investing practice. The fund industry needs to find a way to address this problem.”
In its order in the Transamerica case, the SEC asserted that the firm and its affiliates launched the Tactical Income Fund “without first confirming that the models worked as intended” and that the fund was run by an analyst “with no experience in portfolio management.”
The investing software the analyst designed for the Tactical Income Fund, according to the SEC order, was riddled with errors in “logic, methodology and basic math,” including faulty calculations, shifting formulas and percentages that didn’t even add up to 100%.
Transamerica settled the SEC proceeding without admitting or denying the findings. “The company has addressed the issues raised by the investigation, enhancing its compliance and due diligence policies and procedures, as well as its training programs,” says a spokesman. “The employee who developed the models at issue is no longer with the company,” he adds, declining to identify the analyst. Those models are no longer in use, and the fund has been under different management since 2015, says the spokesman.
The Transamerica case says more about mutual funds in general than it does about this fund in particular. Transamerica Tactical Income was run, according to the SEC, by an inadequately supervised rookie who didn’t know how to design an investment model. Yet the fund outperformed half its peers over the period in question.
“Who was managing the funds that performed worse?” the investment analysts Paul Sonkin and Paul Johnson asked in a blog post this week. “What kinds of models were they using????”
Every once in a while, a Wall Street Journal columnist envies the punctuation of people who don’t have to follow a stylebook.
And fund companies need to overhaul their playbook if they want to earn back the confidence of investors.
Write to Jason Zweig at [email protected]