This week we go in search of equity funds that have delivered above-average returns as adjusted for risk along with excellent tax-efficiency. For purposes of this fund screen, we consider excellent to mean a Morningstar tax-efficiency ratio (the ratio of tax-adjusted returns to pretax returns) of 95% or more. The highest possible score is 100%, which would apply to a fund that had no taxable distributions, such as some municipal bond funds. Note that Morningstar's tax-efficiency ratio excludes additional gains, taxes, or tax losses incurred upon selling a fund.
Because of the high tax-efficiency, these funds are suitable for taxable accounts and investors who seek long-term capital growth with minimum tax implications. Morningstar says that the benefit of using tax efficiency ratios is that they provide a contrast to tax-adjusted historical returns, which measures the bottom-line aftertax results of a fund, without regard to pretax performance. Tax efficiency, on the other hand, measures whether the portfolio manager has kept an eye on tax consequences.
Fund Screen Process
This week's screen was done using Morningstar data as of 7-31-01. Below is a summary of the screen's search criterion.
Prospective Objective = Domestic Equity
Front Load = 0.00%
Deferred Load = 0.00%
Minimum Initial Purchase < or = $5000
Not Closed to New Investment
Not Institutional
Not Qualified Access
Brokerage Availability = Schwab Retail
Morningstar (3-Year) Rating = or > 4 Stars
Morningstar (5-Year) Rating = or > 4 Stars
Standard Deviation (3-Year) < 30%
Standard Deviation (5-Year) < 30%
Tax-Efficiency Ratio (3-Year) > 95%
Tax-Efficiency Ratio (5-Year) > 95%
The domestic equity objective includes all diversified U.S. stock funds tracked by Morningstar. Therefore, sector funds and hybrid funds are excluded from the screening process. We have brokerage availability set to Schwab Retail because it's the largest mutual fund network and we're trying to weed out funds with only limited brokerage availability. Institutional funds and funds which have qualified access are also excluded.
We asked for Morningstar 3-year and 5-year ratings of at least 4 stars to give us funds that have outperformed the domestic stock fund group on a risk-adjusted performance basis. We capped fund volatility as defined by standard deviation at 30% over the past 3-year and 5-year periods. We did this to ensure that we do not wind up with a highly volatile fund. We seek high total returns consistent with reasonable risk and high tax-efficiency. Lastly, we said give us funds with tax-efficiency ratios of over 95% for the past 3-year and 5-year periods.
The screen criterion set forth above yielded three fund results:
Muhlenkamp (MUHLX)
Excelsior Value & Restructuring (UMBIX)
Matrix Advisors Value (MAVFX)
These three tax-efficient stock fund winners are profiled below.
Muhlenkamp (MUHLX)
Ron Muhlenkamp manages this $503 million mid-cap value offering, which seeks high total return consistent with reasonable risk by investing primarily in common stocks. In security selection, he favors stocks of companies of all sizes with low price valuations and high returns on capital. The fund primarily purchases issues listed on major exchanges.
According to Morningstar, Muhlenkamp has consistently maintained its value style of investing. Since it has a median market cap of $4.3 million, Morningstar categorizes this fund as 'mid-cap'. However, all-cap is a more accurate term since he'll find value among company stocks of all sizes, large to small. Total stock holdings are 62 per Morningstar, with low turnover of just 32%, contributing to the fund's high tax-efficiency ratio.
For the 5-year period through 7-31-01, the fund has an average annualized return of 21.6%, outperforming the S&P 500 index by 6.3% a year over this period and ranking in the top 11% of all mid-cap value funds tracked by Morningstar. In relation to all domestic stock funds, Muhlenkamp is rated as having high return and average risk, for a Morningstar 5-star overall rating. The average domestic equity fund (sector funds and hybrids excluded) earned an average 12.7% return over the trailing 5-year period, per Morningstar.
Muhlenkamp has an expense ratio of 1.28%, slightly below average compared to the average stock fund tracked by Morningstar. But, the fund's real appeal is its high tax-adjusted returns and tax- efficiency ratio. Muhlenkamp runs this fund like it's the only stock fund you'll ever need, and he makes a strong argument.
Excelsior Value & Restructuring (UMBIX)
This $2.2 billion offering seeks long-term capital appreciation. David Williams, the fund's original portfolio manager (since 12-92), seeks to achieve the fund objective by investing primarily in equity securities issued by companies he expects to benefit from the restructuring or redeployment of assets. These include companies involved in mergers, consolidations, liquidations, spin-offs, financial restructurings, and reorganizations.
According to Morningstar, Williams has consistently maintained a large-cap value bias over the past 3 years. However, you should note that the current portfolio has more exposure to mid-cap and small-cap stocks than in recent past, for a median market cap of roughly $10 billion. True to its moniker, the fund consistently maintains a value style of investing. This fund has 76 holdings plus a low turnover rate of 20%, contributing to the fund's high tax efficiency.
For the 5-year period through 7-31-01, the fund has an average annualized return of 20.8%, outperforming the S&P 500 index by 5.5% a year over this period and ranking in the top 1% of all large-cap value funds tracked by Morningstar. Relative to all domestic stock funds, Excelsior is rated as having high return and average risk, for a Morningstar 5-star overall rating, like Muhlenkamp. The average domestic equity fund (sector funds and hybrids excluded) earned a 12.7% average return over the past 5 years, per data from Morningstar.
Excelsior Value & Restructuring has a low expense ratio of 0.99%, well below average (1.42) and adding to the fund's appeal. Fund investors seeking tax-efficient capital growth through investment in companies in the midst of streamlining their businesses have a fine choice here.
Matrix Advisors Value (MAVFX)
This relatively unknown 4-star rated fund with $42.5 million in assets has been delivering solid risk-adjusted and tax-adjusted returns since its inception in July 1996 under the direction of David Katz, the firm's founder and chief investment officer. It seeks capital appreciation and current income through investment in common stocks of companies judged to be financially sound and that meet specific valuation criterion. In choosing securities, Katz favors companies with strong financial positions and low current stock market valuations compared to investment value as measured by historic and current earnings, dividends, return on equity, and book values.
According to Morningstar, the fund was classified in the mid-cap value category for most of its history, but recently has drifted up into large-cap value territory with a median market cap value of $17.1 billion as of 7-31-01, with 60% of assets in large-caps and 30% in mid-cap stocks. Katz holds just 44 positions in the portfolio and doesn't churn the portfolio. At 33%, the fund's turnover rate is low and a contributing factor in its high tax efficiency ratio.
For the 5-year period through 7-31-01, the fund has an average annualized return of 16.9%, outperforming the S&P 500 index by 1.6% a year over this period and ranking in the top quartile in Morningstar's mid-cap value category. In relation to all stock funds, Matrix Advisors Value is rated as having above-average return and average risk, for a 4-star rating. For comparative purposes, the average domestic equity fund (sector/specialty funds and hybrids excluded) had an average 12.7% return in the last 5 years, according to Morningstar.
The fund has an expense ratio of 1.22%, slightly below average compared to the average stock fund tracked by Morningstar. It provides solid after-tax and risk-adjusted return performance, and is a suitable choice for long-term taxable fund investors.
