Close Close

Financial Planning > Tax Planning

Is a Tax Bomb Looming for PIMCO Investors?

Your article was successfully shared with the contacts you provided.

The exit of Bill Gross as manager of the PIMCO Total Return Fund has led to investor outflows, Morningstar downgrades, platform exclusions and more. For Total Return investors, there’s also the possibility of a mammoth 2014 tax bill.

PIMCO shareholders yanked a net $23.5 billion from the Total Return fund last month, including $446.5 million on Sept. 26, the day Gross announced his abrupt departure. And the massive outflows are likely to have negative tax implications for remaining investors who own the fund in taxable investment accounts. 

To deal with redemptions, PIMCO has been selling fund assets. And the evidence shows, as these outflows are already affected big positions held by the fund.

The Total Return’s largest holding as of Sept. 25 – $201.3 million of bonds issued by Ontario, Canada – have been sold, according to the fund shop’s website.   

The Total Return’s annual report (published in March, when Gross was still at the helm) indicated that its annual turnover was a very elevated 227%.

Portfolio turnover above 100% indicates heavy trading activity (buying and selling), rather than a buy-and-hold approach. If 227% turnover was the fund’s turnover when Gross was in charge, what could it be today?  

According to a report from Paris-based brokerage group Kepler Cheuvreux, the Total Return Fund might suffer withdrawals of up to $150 billion or two-thirds of assets. In that scenario, the Total Return’s post-Gross portfolio turnover could approach 500%.

Yikes! The cause of such ugly turnover would be selling by the Total Return’s new fund manager to meet shareholder redemptions.

Another measure of the Total Return fund’s tax efficiency (or lack of it) is the tax-cost ratio.

Like a mutual fund’s expense ratio, this tally measures how taxes impact a mutual fund’s performance. The higher the tax- cost ratio, the bigger bite on fund performance due to taxes.

Over the past three years, the Total Return fund has had an average tax-cost ratio of 1.49%, according to Morningstar. That means Total Return fund shareholders have lost 1.49% of their assets to taxes on average.

That’s not an insignificant number, especially factoring in another 0.46% of annual expenses for the institutional share class. Investors who own other share classes pay even higher fees, so combining these expenses with the tax-cost ratio pushes the total cost above 2%.

At the end of September, those owning Total Return Institutional shares (PTTRX) faced potential capital-gains exposure of 1.91% or almost 2% of a NAV near $10.90. As selling intensifies, the potential tax liabilities are likely to increase.    

It’s important to remember the tax bite facing Total Return investors who decide to keep their shares isn’t a problem exclusive to them – it’s a problem facing all mutual fund investors: The fact that redeeming investors can impact remaining shareholders with their selling is a major structural flaw of mutual funds that doesn’t exist with ETFs.

Why was a financial product designed so that one group’s selling activity ends up becoming another group’s tax bill?

The bottom line is this: tax efficiency was never the Total Return fund’s forte with Gross as its leader. Now that he’s gone, the immediate tax situation for remaining shareholders is not likely to be much better.

More by Ron DeLegge on ThinkAdvisor:


© 2023 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.