Fewer Capital Gains One Bright Side of Bear Market.

THE usual yearend commotion over mutual-fund taxes promises to be awfully quiet this year.

Thanks to a relentless bear market, most people who own shares of stock funds will see far less in capital gains distributions than they're accustomed to.

The way people grumbled about taxes as the amounts of these distributions soared over the past several years, you'd think they'd be glad for the break. But of course they aren't. Just because they dislike gains distributions didn't mean they wanted to dispense with gains altogether.

Whatever happens next, one thing is clear. The tax system in this country has been beautifully designed to ensure that everybody will always have something to be unhappy about.

Consider this While in good times funds must pass through all gains they realize to investors each year, they cannot do the same with losses. Or t is: If you or I sell fund shares at a loss, the most we can normally write off for tax purposes a against our non-investment income is a paltry $3,000 a year (or maybe $4,000, if a proposal now in Congress somehow makes it into law).

The situation could be a positive for the stock market, in the sense that fund managers probably aren't doing much tax selling of stocks right now. Or it could be a negative for the stock market, in the sense that individual investors will probably do plenty of tax selling of a1ready-depressed stocks between now and Dec. 31.

Fond memories

All in all, it's enough to make you nostalgic for the good old "oh no, not another gains distribution!" days Memorable days they were. In 1995, according to Investment Company Institute data, funds passed through to their shareholders a record $54 billion in capital gains distributions. Except in tax-deferred vehicles such as individual retirement accounts or 401(k) plans, investors must pay current taxes on these, even when they automatically reinvest the money in new fund shares.

The total nearly doubled in 1996, when it reached $101 billion, and again in 1997, when it hit $183 billion. By 2000, it ballooned to $325 billion, as funds continued to realize big paper profits hey had built up through a historic bull market, even as the market averages turned down.

And what did this cost in taxes? Looking at ICI numbers, of the 2000 total, $226 billion went to tax-deferred accounts or to "non-house-hold" recipients such as investing institutions not subject to individual income taxes.

The remaining $99 billion was distributed to taxable household accounts, which at the top long-term capital gains rate of 20 percent would still have meant a cool $19.8 billion for Uncle Sam. How's that for a budget surplus enhancer?

This year distributions are sure to be down, though by how much remains to be seen. The second largest fund firm, Vanguard Group, says more than two-thirds of its stock and bond funds expect to make no gains distributions for 2001.

Another big. manager, Capital Research & Management Co., says seven of its American Funds am expected to pay distributions amounting to less than 5 percent of net asset value, while 22 others stand to make "nominal or no" distributions.

The paucity of payouts may mandate a few changes in tactics for fund investors. At the same time, though, it really ought not to exert much influence on most people's longer-term strategies.

At quite a few funds, investors who normally hold back on buying new shares until after the yearend payout date so as not to "buy a distribution" may not have to bother with that precaution this year (check with individual funds to be suru).

Where they once shied away from funds with large unrealized capital gains, tax-conscious investors may now start shopping instead among funds with sizable tax losses they can carry forward to future years. Even if stocks rally, these funds might not pay out much in distributions for some time to come.

The trouble with this kind of finagling is that it can sidetrack you from your fundamental investment strategy. Long-term investors might be better served shrugging all this off, and simply sticking with their strategies as before.

Might as well make the best of it. Enjoy the respite from taxes on distributions.

Chet Currier is a columnist with Bloomberg News.

Emphasizing Skill Over Manager Style

For a long stretch in the mid- to late-1990s, stock funds that specialize in large growth companies were the standouts among the nine categories popularized by the Morningstar Inc. "style box."

Small growth surged to the fore in 1999, only to be displaced in 2000 and the first half of 2001 by small value funds. In the third quarter of this year, mid-cap value took over as the leader, if you can use that word. It dropped a little less precipitously than the other categories in a take-no-prisoners market rout.

Over the last decade, all nine style-box groupings have averaged annual gains of 10.7 percent to 13.9 percent. Any one that goes on a run over the next couple of years could take over the long-term lead.

So where's the difference in these distinctions? "The most prevalent equity manager classification systems are disappointing investors," says Barra Strategic Consulting Group, a prominent consultant to money managers, in a recently published paper. "The simplicity of these frameworks does not appropriately differentiate between manager types, nor correctly assess their performance."

Barra argues instead for adoption of a more sophisticated "style footprint" system of analysis - a "multi-faceted view of style."

The trouble with style started when people tried to make the categories into a basis for sweeping research conclusions or asset-allocation strategies. In some cases, investors seemed to get the impression they were supposed to classify themselves as growth or value loyalists, taking some sort of ideological stand.

On that point Barra analysts seem to agree. "in future, there will be a greater appreciation of and demand for skill (emphasis theirs)," the consulting firm says. "We define 'skill' as the excess return added after controlling for broad market movements and style exposures. Skill rather than style will become the dominant criterion for selecting a manager."

Chet Currier