Question about very low capital gains in Schwab target date index funds

[Curly]

We are using Schwab Target Date Index funds in all accounts at Schwab. One thing that I would like to understand is the method used by the managers of the funds to keep short- and long-term capital gains at zero, or nearly at zero. With a few exceptions, the distribution history of each fund, since inception, has had either no CGs or very small CGs. By small, I mean fractions of a cent for some CGs.

These funds (except the 2065 fund) were started 8+ years ago (August 2016), so the portfolio allocations have evolved. The underlying ETFs have increased in value. It seems at first glance there must have been assets in each fund that needed to be sold to make room for newer assets (for example: increasing the amount of SCHZ--aggregate bond ETF/reducing the amount of SCHX--US large cap ETF, as the 2050 fund evolves into the 2045 fund).

At first I was thinking that maybe Schwab can just move the ETFs as needed around the various individual funds, in a sort of giant reallocation accounting process. But each fund is a standalone entity, so maybe that isn't right.

If anyone has info about how this works, I would be most interested in learning more. Thanks.

For reference: go to this link, scroll down about halfway to see the year for each of the funds. Click on a year and look at the distribution history.

https://www.schwabassetmanagement.com/products/stir

[Hyperchicken]

Maybe they had realized losses? Funds must distribute realized gains, but can carry realized losses to offset gains before distributing what's left of gains, if anything.

Or the inflow of money allows them rebalancing with new money without selling much.

Looks like fund managers are good at what they are doing.

[Curly]

Thanks for your comments. Maybe it is just a simple as this and not some esoteric strategy. You're right--they do seem to be threading the needle and have balanced things well.

Maybe they had realized losses? Funds must distribute realized gains, but can carry realized losses to offset gains before distributing what's left of gains, if anything.

Or the inflow of money allows them rebalancing with new money without selling much.

Looks like fund managers are good at what they are doing.

[MnD]

These are funds composed of ETF holdings and not individual stock/bond holdings.
ETF's use techniques to avoid realized capital gains and the so the fund benefits the same way.

[rkhusky]

ETF’s have special mechanisms for washing cap gains. Most other TDF’s use mutual funds that don’t have the same mechanism.

[typical.investor]

These are funds composed of ETF holdings and not individual stock/bond holdings.
ETF's use techniques to avoid realized capital gains and the so the fund benefits the same way.

Sure, but tax advantage of an index ETF over an index mutual fund is pretty small. If you look at capital gain distributions in total market index mutual funds, you will see they are often zero but higher in some years (around 2015 for instance). On average, it only looks to be around a 0.03% advantage for the ETF index fund but again it depends on time frame and fund.

These funds (except the 2065 fund) were started 8+ years ago (August 2016), so the portfolio allocations have evolved. The underlying ETFs have increased in value. It seems at first glance there must have been assets in each fund that needed to be sold to make room for newer assets (for example: increasing the amount of SCHZ--aggregate bond ETF/reducing the amount of SCHX--US large cap ETF, as the 2050 fund evolves into the 2045 fund).

Then as Curly points out, the funds need to rebalance to hit their target allocation. Selling SCHX, if there are no fund inflows which would allow fund managers to simply buy other ETFs such as SCHZ without selling, would mean all capital gains distributions that were washed out by the ETF mechanism (ETFs just defer until sale, they don't eliminate tax on capital gains) and the unrealized capital gains the shares have would be realized.

Of course, if the fund needed to sell SCHX to rebalance, the managers perhaps could select those shares with highest cost basis to get rid of in order to purchase more SCHZ.

So it's probably a combination of the timing of when the funds index funds need to issue capital gains, and fund inflows which could offset the impact of fund rebalancing and the managers doing what they can to keep capital gains distributions (from rebalancing) down. That's my guess anyway.

[grabiner]

Target-date funds for investors before retirement are likely to have much more inflows that outflows, so they can rebalance and change allocation without selling anything, and will only distribute capital gains if the underlying funds do.

[Curly]

Thanks to all who posted. Maybe it is just the simple answer that inflows are sufficient at this time to handle the need to balance a given fund without any CGs being generated. And the managers' skill at managing.

I have read various descriptions of how ETFs are able to work their magic and avoid CGs, but figured that wouldn't apply to these Schwab index TDF because they are mutual funds.

[Lyrrad]

Thanks to all who posted. Maybe it is just the simple answer that inflows are sufficient at this time to handle the need to balance a given fund without any CGs being generated. And the managers' skill at managing.

I have read various descriptions of how ETFs are able to work their magic and avoid CGs, but figured that wouldn't apply to these Schwab index TDF because they are mutual funds.

I think there's some undisclosed mechanism or technique that some non-Vanguard index mutual funds have been using in recent years to significantly reduce or mostly eliminate capital gains distributions.

For example, FXAIX (Fidelity S&P 500 index fund) from Fidelity has not had a capital gains distribution since 2019. Their Freedom Index Target Date retirement funds also seem to have very low capital gains distribution, with the 2045 target date index fund (FIOFX) last having a very small capital gains distribution in 2022, though they expect to distribute about 0.1% of NAV this year, as of September 30.

It was discussed earlier this year in relation to Fidelity in this thread, but no conclusion was reached.

[gavinsiu]

I have been wondering about this, too.

Here's the distribution from Morningstar

Fidelity Freedom Index 2050


Schwab Target Index 2050


Vanguard Target Index 2050


What's interesting is that both Fidelity and Vanguard distributed capital gains, but Schwab has not. Vanguard shows an extra large distribution on 2021, which I believe was due to them merging target funds resulting in a lawsuit. The question is which one is still more tax efficient? How do you calculate distribution percent return, is it the distribution / NAV? If this is the case

Fidelity = 0.0040/21.17 + 0.4460/23.28 = 1.93%
Schwab = 0.3313/16.61 = 1.99%
Vanguard = 0.9844/44.52 = 2.21%

It seems that they are all about the same on distribution.