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A fund sells a portfolio security at a gain. What normally happens next for shareholders?
AThe gain is added to the fund's next 12b-1 fee
BThe gain stays inside the fund and is never paid
CThe gain is credited only to redeeming investors
DThe gain is distributed to shareholders year end
Answer & Solution
Correct answer: D. The gain is distributed to shareholders year end
1. Selling a portfolio security above its cost gives the fund a capital gain.
2. At the end of the year most mutual funds and ETFs distribute those gains, net of capital losses, to shareholders.
3. The distribution goes to all shareholders of record, not only to those redeeming.
4. ETFs try to minimise these gains by making in-kind exchanges with redeeming Authorized Participants instead of selling securities.
5. A 12b-1 fee is a distribution charge on fund assets and has nothing to do with realised gains.
_Source: US SEC Office of Investor Education and Advocacy, "Mutual Funds and ETFs: A Guide for Investors", section How Mutual Funds and ETFs Can Provide Returns to Investors_
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