Investors in the $4 billion Templeton Foreign Fund already have lost more than 50 percent of their money this year and now they’ll be forced to pay taxes on as much as $1 billion of gains from the sales of investments.

Shareholders of Templeton Foreign, run by Franklin Resources Inc. in San Mateo, California, have plenty of company. Franklin said 33 of its 106 stock and bond funds will have capital gains. Fidelity Investments, the world’s largest mutual-fund manager, expects 135 of its 212 funds to make the distributions, based on data as of Nov. 15.
Money managers have had to sell profitable holdings this year as customer redemptions increased, resulting in short- and long-term capital gains. The result means tax bills for investors in the worst year for financial markets since the 1930s.
“It feels like a sucker punch for investors to pay taxes on gains when you’ve lost so much money,” said Christopher Davis, an analyst at financial researcher Morningstar Inc. in Chicago.
The last time investors were hit with capital gains during a losing year was in 2001, when they paid $9.9 billion in taxes on fund distributions after the collapse of the Internet bubble, according to Lipper & Co., a Denver-based financial-research firm. In 2001, the Standard & Poor’s 500 Index declined 13 percent, compared with 40 percent this year.
The average U.S. diversified stock fund slumped 48 percent this year as of Nov. 21, while funds investing in non-U.S. stocks fell 54 percent, according to Morningstar. Stock-fund assets declined 40 percent to $3.32 trillion as of Oct. 31 after almost $2.1 trillion of investment losses and $140 billion of withdrawals, Morningstar data show. Equity and bond funds are subject to capital gains, although fixed-income securities tend to generate smaller distributions. Short-term capital gains, on investments held less than a year, can be taxed at a rate of as much as 35 percent. Long-term gains, on investments owned more than a year, have a 15 percent tax rate.
Funds also pass through dividends and interest paid by the stocks and bonds they own. Municipal bond funds are exempt from federal taxes, and in some cases, state taxes.
The industry distributed a record $581.6 billion to investors in 2007, leading to federal tax bills for shareholders of $33.8 billion, according to Lipper.
“In a good year, capital gains may be unavoidable, but in a bad year, it adds insult to injury,” said Daniel P. Wiener, who oversees more than $1 billion as chief executive officer of Newton, Massachusetts-based Adviser Investments.
Funds that invested in natural-resources and emerging- markets stocks, which had big gains in 2007, will make the largest distributions this year, Morningstar’s Davis said. Franklin spokesman Matt Walsh said in an e-mail that the company sold profitable holdings that appreciated over several years.
“The markets are coming out of a tremendous multiyear period of strong performance, and as a result, many funds are holding positions that have appreciated significantly from the time of purchase,” Walsh said.
At Fidelity, the $1.6 billion Select Energy Portfolio and the $494 million Europe Capital Appreciation Fund will make distributions, according to preliminary estimates on the Boston- based firm’s Web site.
Select Energy, which gained 46 percent in 2007, has lost 51 percent this year. It will pay an estimated $2.85 a share in distributions in December. The payout represents 6 percent of the fund’s net asset value as of Sept. 30, Fidelity said. Europe Capital, which has declined 51 percent this year, plans a distribution of 51 cents a share, or 2.7 percent of net asset value.
“Commodity and natural-resources funds are areas where we could see higher levels of distributions,” said Fidelity spokeswoman Sophie Launay. Overall, distributions “will be significantly lower” than in past years, she said. Fidelity oversees about $1.4 trillion for customers.
The company’s biggest stock fund, the $52 billion Contrafund, has an estimated payout of 22 cents a share, equal to about 0.5 percent of net asset value as of Sept. 30. Contrafund has fallen 22 percent since then, bringing its decline this year to 39 percent.
Vanguard Group Inc. in Valley Forge, Pennsylvania, has made preliminary capital gains estimates for 16 funds, including Vanguard Precious Metals and Mining Fund. The $1.7 billion fund may pay a distribution of $1.95, or 14 percent of its net asset value, even as it tumbled 63 percent this year.
(Source: Bloomberg)