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Owning funds can be a taxing experience

But there are a few strategies investors can use to minimize the hit


It pays to be tax savvy when buying stock mutual funds outside the shelter of a registered retirement savings plan.

Obviously, you will be hit with a tax bill on capital gains after selling a fund that has made money. But you may also get a taxable distribution if your manager is an active trader.

Even managers who have historically been patient investors have been caught up with more buying and selling in the volatile and range-bound markets of recent years.

"Across the board, the turnover has gone up so there might be tax implications," said Al Kellett, a fund analyst at Morningstar Canada.

One way to avoid taxes is to set up a tax-free savings account (TFSA) to buy mutual funds, but this can be a limiting option since investors are only allowed to contribute $5,000 a year.

Another option is to buy the corporate class version of the fund you like if it is available. That will enable you to sell and buy investments within the same fund family, and defer paying tax on the capital gains.

Corporate class funds used to have higher fees, but more firms are now charging the same management expense ratio (MER) for the traditional and corporate class investments.

You can also look for traditional mutual funds with a low portfolio turnover rate so that there is limited or no capital gains distribution.

You can find a fund's annual turnover rate in the management report on fund performance (MRFP) - a document that can be requested from a fund company.

Or, you can search for funds with large capital losses that can be carried forward in future years to reduce or wipe away potential gains. This information is available in fund's financial statements.

To find some tax-smart funds that might be worth a closer look, we tracked down a few mutual fund analysts to find out which savvy funds they are recommending now. Funds with a corporate class version in their fund family will be indicated by the letter "C."

Al Kellett, fund analyst, Morningstar Canada

CI Harbour (C)

The Canadian stock fund run by Gerry Coleman of CI Investments Inc. has had an average portfolio turnover of 18 per cent over the past five years, he said. The value-oriented manager, who has a strong track record, is also willing to hold cash [about 15 per cent now] if he does not find opportunities, Mr. Kellett added.

Mackenzie Cundill Canadian Security Class (C)

This Canadian stock fund has been co-managed by Lawrence Chin and David Slater at Mackenzie Financial Corp. since early 2009. The deep-value fund has had an average turnover of 45 per cent over five years, but it has not paid a taxable distribution over that time, he said. "While the fund has had different people as lead managers, the team itself has been fairly stable."

Dan Hallett, director of asset management, Highview Financial Group

Mawer Canadian Equity:

The Canadian stock fund, which is run by Jim Hall of Mawer Investment Management, has low fees and has had an average portfolio turnover of 15 per cent over the past five years, he said. As a firm, Mawer uses strategies to reduce taxable gains, including selling losing stocks it still likes to crystallize losses and buying them back later. It focuses on growth stocks trading at reasonable prices.

Brandes Global Equity:

This global stock fund, which is run by U.S.-based Brandes Investment Partners, has underperformed and suffered from redemptions, but it also has a tax-loss carry-forward of more than $900-million, he said. "The fund could go up 75 per cent, crystallize all gains and not pay a cent in taxable distribution." The value fund lagged in recent years because it did not have the hot commodity stocks and invested in some failed companies, but "I believe that Brandes will return to its outperforming ways," he said.

James Gauthier, vice-president of investment funds, DundeeWealth Inc.

Mackenzie Ivy Foreign Equity (C):

The value-oriented global stock fund, which is run by Paul Musson of Mackenzie Financial Corp., has "strong performance [relative to peers], low volatility and low turnover," he said. The fund has a five-year average turnover rate of 22 per cent, but that has fallen in the past three years to 18 per cent. "It focuses on consumer staples - nothing too flashy," he said.

BMO Guardian Enterprise Mutual (C):

The smaller company fund, which is run by Martin Ferguson of Mawer Investment Management, is a "low volatility, low turnover fund," he said. The fund, which has had a 22-per-cent average turnover rate over three years, is run similar to Mawer New Canada Fund, which is capped.

Dave Paterson, fund analyst, D.A. Paterson & Associates Inc.

CI Harbour (C):

Manager Gerry Coleman has delivered strong returns without taking on a lot of risk in his stock fund, while his portfolio has had a low turnover rate that has averaged less than 20 per cent over the past five years, he said. "The fund did not pay a distribution in 2009, but did in previous years."

Mutual Discovery (C):

The global equity fund has been co-run by Peter Langerman and Philippe Brugere-Trelat since December, but "there wasn't a ton of turnover to bring the portfolio in line with the new team's view," he said. Volatility in the value fund is low, while the turnover has averaged 23 per cent over five years.


Analysts' picks for tax-smart mutual funds

(As of June 30, 2010)
NameCategoryAssets* ($millions)LatestMER1-yr3-yr5-yr10-yrIncpt.
BMO GDN Enterprise MutualCdn. Small/Mid Cap Eq.132.32.7530.7%-3.2%5.7%5.9%
Brandes Global EquityGlobal Equity1230.32.57-4.4%-19.5%-8.2%-3.1%
CI HarbourCdn. Focused Equity5639.42.314.9%-4.4%4.6%7.1%7.2%
Mackenzie Cundill Cdn Security 'C'Cdn. Focused Equity1338.02.3819.1%-6.4%0.4%5.6%7.0%
Mackenzie Ivy Foreign EquityGlobal Equity1816.12.431.9%-2.3%1.6%2.4%6.7%
Mawer Canadian EquityCanadian Equity116.81.2610.3%-4.2%4.8%7.7%8.4%
Mutual DiscoveryGlobal Equity511.92.623.5%-8.2%1.3%4.7%
MSCI World ($ Cdn)1.1%-11.0%-2.3%-3.8%
S&P/TSX composite index8.9%-6.7%2.7%1.0%
* as of June, 2010 Source: Globe Investor

© 2007 The Globe and Mail. All rights reserved.

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