Realised Capital Gains.

Capital gains tax is a bit of a misnomer - it is really just a form of income tax in that your net capital gain (or 50% of your net capital gain if assets are held in personal names for at least 12 months) is added to your taxable income at the end of the financial year.

So if you currently earn $30,000 and pay 15% tax, and then get a $70,000 capital gain, your taxable income for the year is $100,000 and you will be paying 38% tax on the amount above $80,000.

With managed funds which pay distributions, there may be some realised capital gains contained in those distributions - usually as a result of them selling down holdings of some of their shares. The more frequently they do this, the more realised capital gains will be distributed. This is often referred to as "churn" - regularly buying and selling shares within a fund. The higher the rate of churn, the higher the likely realised capital gain distribution you receive.

It is important to distinguish the amount of capital gains within the distributed income from a fund - as it will tend to indicate the level of efficiency within the fund. High churn, high distribution funds cost you money because you are taxed on those gains in the year they are made. By contrast low turnover funds which hold shares for longer periods will generally show fewer capital gains and so you won't be taxed except on the real income earned (usually from share dividends or cash interest earnings) - unless of course you sell your units in the fund and realise a capital gain yourself.

Don't be fooled by a fund which shows high income return due to realised capital gains (and thus a high income "yield"). Income is always good, but is not very tax effective - especially if your goal for the fund is growth.

Index funds are generally quite low churn, they don't change their portfolio structure very often (typically only when the index changes its constituents or weightings), so most of the distributions are from dividend income.

Note that some of the CFS index funds I've looked at seemed to have an unexplainably high realised capital gains component in their income distributions - I never did work out why ... so it's still worth checking the nature of the income being paid out by an index fund, just to make sure.

I think the funds management industry needs to be more transparent in reporting the makeup of the income they distribute - just reporting capital gain in unit price plus total income distributed is not enough!

 

Here are my calculations for the Colonial First State (FirstChoice) Index Aust Share fund which show abnormally high levels of income being distributed in previous years (which to me can only really be explained by realised capital gains, since income from the market should average around 7-8%):

Yearly Performance: Colonial First State (FirstChoice) Index Aust Share (FSF0233AU)

I really can't explain why this might be so, and I suspect there might be an error in my data or in my calculations. The funds distributions have certainly been much more in-line with what I expect since then.

You can see last year's data here: Colonial First State: Distribution calendar

 

STW returned about 5.4% yield over the past 12 months.

 

The fees for the retail fund would be higher for starters - that would account for some of the difference ... the other aspect could be the timing of sales leading to realised capital gains being distributed?

Those funds are just a bit too wierd for my liking.