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M*: Taking A Bath: Lessons From A Big Fund's $9 Billion Capital Gains Distribution: (HAINX)

FYI: In general, investing taxable money in active stock funds is a bad idea.

This was vividly underscored last week by Harbor International Fund’s (HAINX) announcement that it expects to make a huge capital gains distribution equivalent to roughly 38% of the fund’s net asset value.
There are lessons to be learned from the Harbor fund’s example, such as giving a wide berth to active stock funds that are sitting on large unrealized gains while experiencing heavy investor outflows.
Regards,
Ted
https://www.morningstar.com/articles/880662/taking-a-bath-lessons-from-a-big-funds-9-billion-c.html

Comments

  • The real lesson was to sell the fund after the death of long-time fund manager Hakan Castegren in 2010. It was one of the top international funds before 2000. Unfortunately, Northern Cross didn't have a successful succession plan in place resulting in mediocre performance in the following years.
  • I'm not sure what you're saying here. Is it that Harbor should have fired Castegren in 2000, since that's the last good year you identify? In that case, perhaps it was Ivy International Growth (now Ivy Global Growth) IVINX that had the right idea. Ivy induced Castegren to quit in 2000 by refusing to close its fund.

    More likely, it was Ivy, not Northern Cross that had no succession plan. I don't believe Ivy was expecting Castegren to quit. It plunked Reilly in as manager for 1.5 years, followed by McLachan for another year. Only then did it settle on a long term manager with Mengel. In those intevening couple of years, IVINX returned -17.26% (2000), -21.03% (2001), and -20.96% (2002).

    In comparison, HAINX had returns of -4.97% (2000), -12.25% (2001), and -6.38% (2002).
    For a frame of reference, TEMFX had returns of -3.67% (2000), -7.92% (2001), -8.64% (2002).

    Northern Cross had a succession plan in place. For almost two years before Castegren died, starting Feb 2009, Castegren was joined by Ducrest, LaTorre, and Wendell. For the two years of overlap, and the two years following, HAINX put up good to very good numbers: 17th percentile (2009), 31st percentile (2010), 17th percentile (2011), 17th percentile (2012).

    Those managers did not maintain their fine performance. However, the succession was planned and the fund continued to perform well through the transition.

    The lesson to be learned is when a fund does not have a smooth succession plan (successful or otherwise), you may expect a portfolio overhaul and large amounts of cap gains realized. Harbor just fired Northern Cross. That's what caused the gains to be realized.
  • HAINX = Heinous
  • So I'm one of the poor SOBs thats still in this fund. Have held since '94. I assume I should sell my position as soon as possible? Is there any way I can limit the cap gains I get hit with? Makes me sick thinking about it.
  • Well, as my investment-adviser father once put it, the whole point of investing, ultimately, is 'to pay as much tax as possible'.
  • edited August 2018
    I still have it and glad it is in my non-taxable account. This is an indication of what may happen when you change fund managers/sub-advisers:

    https://www.morningstar.com/articles/880213/harbor-international-under-review-after-subadvisor.html
  • MikeW said:

    So I'm one of the poor SOBs thats still in this fund. Have held since '94. I assume I should sell my position as soon as possible? Is there any way I can limit the cap gains I get hit with? Makes me sick thinking about it.

    If the projected distributions (cap gains plus usual annual divs) exceed the gains you'll realize by selling, then sell. I've done this on rare occasions and even bought back after distributions if I liked the fund. If the gains you recognize by selling are greater than the projected distributions, then the large distribution isn't a reason in and of itself to sell.

    That said, even if the gains you recognize will be greater than the distributions, this would be the time to sell the shares if you want out. With new management and a new portfolio, HAINX is effectively a new fund. Is this new fund one you want to own in preference to another fund (or cash)? I haven't researched the new management, so I can't comment on the new fund. There are other good, known funds available as alternatives.

    Another way to avoid the gains is to donate the shares to charity. With the new tax laws, it's less likely you'll be able to itemize, but if there are donations you were planning to make anyway, this is a good way to do that.

  • It seems the capital gains will be long term, so that would be the best type of gains to have for tax purposes. However, funds are not required to distribute in the most tax-favorable manner.

    I used to own the fund until it became a stinker. I think this was a fund that gave off “sell” signals a long time ago. I wish all my sales had been so prescient.
  • @msf
    Thanks for feedback. If i sell now do you know if I'll still get hit with the cap gains distributions they'll do later in year? That would be a double whammy of my cap gains plus the distributions from the fund
  • Ive held the fund for 24 years so lots of cap gains
  • Harbor is saying that it will realize all gains in the portfolio this year. If all gains are realized, any attempt to optimize by selling lowest gain shares first would be pointless.

    Still, I agree that the vast majority if not all of the net cap gains realized will be long term. That's for a few reasons:

    - Very low turnover (13%), so on average, investments have been held for 4 years. Think of a portfolio filled with investments held 8 years then sold; half will be under 4 years old at the moment, half more. In any case, very few holdings owned for under a year.

    - Net losses this year; YTD performance -2.73%. So holdings purchased this year may easily have dropped in value; at least enough so that short term losses should wipe out any short term gains.

    - New management building a new portfolio - it's very unlikely that the new management is buying securities now just to dump within the fiscal year. They're not about to generate additional short term gains with their own purchases.

    Here's the source for M*'s estimated 38% distribution.
    https://www.harborfunds.com/HIF_manager_change_QA.htm#7

    It's worth keeping in mind the dollar amount of the expected distribution, more so than the percentage. Harbor estimates that $9B will be distributed in cap gains: $4.5B already recognized, and nearly all of the $4.5B unrealized gains are expected to be realized.

    The current AUM of the fund is $20.8B, so that comes out to 9/20.8 = 43%. (This is just slightly higher than the 41% one gets by taking Harbor's high end distribution of $27 and dividing by the current NAV of $64.94.)

    So watch that AUM. As it drops (people sell), the $9B won't change, but the denominator will get smaller and smaller.
  • msf
    edited August 2018
    MikeW said:

    @msf
    Thanks for feedback. If i sell now do you know if I'll still get hit with the cap gains distributions they'll do later in year? That would be a double whammy of my cap gains plus the distributions from the fund

    Nope - it's an either or. You realize gains on your own shares when you sell, or you hold and get hit with their distributions. Only way you get a double whammy is if you sell after the distribution. But even then, your sell price has dropped because of the distribution, so you don't see more income by selling just after instead of just before a distribution.

    If you sell now and others don't, the AUM of the fund declines, and they get hit with even higher distributions. That $9B in gains is distributed among fewer owners (i.e. fewer shares).

    (Each time I edit, I keep on thinking of more to write; let me know if a hypothetical numeric example would help.)
  • @msf thanks very much for explaining this. Very helpful. Seems like there is more risk in holding onto my shares because others could very well be selling which would result in higher distributions to those left. I also looked at the track record of the new subadvisor with another Harbor fund and its not impressive. Very disappointed with harbors lack of stewardship for shareholders.
  • msf
    edited August 2018
    You got it. It sounds like you want to exit. If you are going to exit, selling before distribution is better.

    Either way, your gross income will be the same (except for potential appreciation/loss while waiting to sell). But in terms of tax you're better off selling now.

    Sell now, and virtually all your income will be long term capital gains (except for any shares purchased within the last year, and those probably lost value).

    Wait for distributions, and a small amount of the distribution may be ordinary income (vs. long term cap gains or qualified divs).

    No other real difference. Sounds like you want to get out. So get out now, while the getting is good. :-)
  • @MikeW: I’d be interested in any conclusions you might reach regarding Harbor’s success hiring and firing sub-advisors. I used to also own Harbor Mid Cap Value and Harbor Global Growth. I’m pretty sure Harbor fired Marsico from the latter. Beyond these three funds, I don’t know Harbor’s lineup.
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