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The Huge Tax Bills That Came Out of Nowhere at Vanguard

By Jason Zweig, WSJ (Free Link)

A change that benefitted big clients left little ones holding the bag

Read Here

Comments

  • Did “Sitting-Hawk,” have the peace of mind to leave VG ?!
    I wined about this crock of BS awhile back.
    Thankfully I had only a small amount in these TDF's .
    On the other hand ,if one had CG's distributions coming in cash,instead of reinvestment,one could now be buying more shares for less. I guess tax bracket would come into play.

    Enjoying the ride, Derf
  • "Vanguard’s target-date series is making headlines this week because of an unusually high capital gains distribution that has riled investors in taxable accounts and drawn scrutiny from regulators.
    It has sparked debate over whether target-date funds are suitable for taxable accounts."


    Link
  • @Observant1 : Thank you for the link.
    Part of the 1%, Derf
  • msf
    edited February 1
    unusually high capital gains ... has ... drawn scrutiny from regulators
    debate over whether target-date funds are suitable for taxable accounts

    The high Vanguard distributions were the result of a technical change Vanguard made. It lowered the min for institutional funds, thus triggering a mass selloff by small company plans as they migrated from retail clones into the institutional funds.

    Once one realizes this, the two statements above come off as a nonsequitor.

    Suppose that instead of target date funds, Vanguard had lowered the min of VITPX from $100M to $5M. (For the sake of argument, assume VITNX, VSMPX, and VITSX did not exist.) One would expect to see a similar migration of small employer plans from the retail fund VTSAX to the institutional clone VITPX.

    This in turn could trigger a large cap gain distribution to the remaining retail investors. VTSAX has unrealized cap gains amounting to about half of the fund assets, according to M*.

    Surely one would not suggest that a total stock market fund was an inappropriate choice for a taxable account, just because a poorly planned change could could trigger a torrent of recognized cap gains.

    This is a completely different question from whether target date funds are suitable for a taxable account.
  • Those 2 distinct VG TDF series were going to be merged. To make ER & min requirement adjustments just a few weeks ahead of the merger was very poor planning by VG that caused unnecessary disruptions & harmed the retail taxable investors. It doesn't matter why those retail taxable investors were in the TDF. If so inappropriate, VG (and others) shouldn't have the TDF open to retail taxable clients. Anyway, the MA regulator is looking at this and other strange things by several TDF vendors.
  • edited February 1
    Deleted.
  • msf
    edited February 1
    If an investor does a tax-free conversion of one share class of a fund into another share class, e.g. investor class to admiral class, there are no tax consequences.

    But if an investor sells one fund and buys another, even if the second fund is a clone of the first, two taxable things happen:

    1) If this is a taxable account, the investor may recognize gain on the sale, and

    2) The old fund may have to sell assets to satisfy the redemption, and in the process generate cap gains that may be distributed to the remaining (old) fund shareholders.

    That's what happened here. The employer plans were not exchanging share classes in the same fund, but were literally selling shares of one fund and buying shares in a virtually identical but separate fund.

    ---

    The simple response to your second observation is yes, that's generally correct. The complete answer is a bit more complicated.

    Any fund, whether active or passive, ETF or open ended, can alter its portfolio holdings in a couple of ways:

    1. Sell the old holdings, buy new ones. This could generate cap gains if the old holdings have appreciated.

    2. (a) When investors want to redeem shares, instead of handing them money, hand them back the old holdings that the fund wants to get rid of. Yes, even OEFs in theory (but rarely in practice) can do redemptions in kind (see link below). For an ETF, the bundle of holdings that the investor receives is called a "redemption basket".
    https://www.dodgeandcox.com/redemption_disclosure.asp (D&C redemption baskets)

    (b) When investors want to buy shares, rather than using cash the fund (ETF) requires the investor to hand over a bunch of new holdings. This bundle of holdings is called a "creation basket".

    Usually the creation basket and the redemption basket are the same, but they don't have to be. This gives the funds the ability to tweak their holdings, handing off old holdings it doesn't want and taking in new holdings that it does want.

    I doubt this is how a passive ETF would deal with a full index reconstitution, but I could envision it being used to replace a single security. So just because an ETF wants/needs to change its portfolio, it doesn't have to recognize gain on the old holding(s).

    (From iShare IG Corp Bond ETF LQD's prospectus: "Creation and redemption baskets may differ ...")
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