ETFs have received a great deal of attention in the press recently as we have noted. This is due in part to their superior tax efficiency versus their open-end cousins. Karen Damato in the Wall Street Journal points out an interesting facet of mutual funds that ETFs cannot match.

When a mutual fund generates net capital losses it is able to carry forward those losses for a period of time (eight years) to offset future gains. Coming off horrible years in 2000, 2001 and 2002 many funds still have sizeable losses today. These losses can be enhanced because of earlier fund redemptions. Theses capital losses get spread over fewer shares. So today’s shareholders are even bigger beneficiaries of yesterday’s losses.

“It’s a big advantage” if an attractive fund has significant loss carry-forwards, says Russel Kinnel, director of mutual-fund research at Morningstar Inc. in Chicago. Buyers don’t have to worry about a tax bill a few months down the road. And, while investors will eventually owe tax if their investment proves profitable, delaying that tax bill “will give you a greater after-tax return over the long haul,” Mr. Kinnel says.

This year, there is another reason to look at some of the funds that have significant loss carry-forwards. Accumulated losses are most common at funds emphasizing large growth-oriented stocks, because those stocks and funds took such a battering in the bear market.

The article highlights a handful of high profile funds that have sizeable capital loss carryforwards. Investors interested in this fund feature should go to and look for the entry, “Potential Cap Gains Exposure %â€? under Taxes. Other resources include the fund company websites themselves.

Two big caveats apply. The first is that this is only relevant for funds that are going to be held in taxable accounts. Seems obvious, but is worth reiterating. The second is that this potential tax “bonusâ€? is only one criterion investors should look at. Investing in a second-class fund with high expenses solely because it has capital loss carryforwards is not a wise decision.

Ken Gregory, a financial adviser in Orinda, Calif., cautions that “it doesn’t make sense to invest in a fund solely because it has loss carry-forwards.” But he says that “one of the silver linings” of the bear market is that fund buyers could find “big capital losses in some very good funds.” Harbor International Growth is one fund he points to. He also cites Brandywine Fund, although the remaining carry-forwards there have been whittled down to under 10% of the recent assets, according to the Brandywine Funds Web site.

As always homework is the key, but adding capital loss carryforwards to your investment arsenal is a great way to use the market’s past losses to provide for future gains.

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