Flows into tax-efficient funds are catching the attention of the mainstream financial press. So far this year those specialist funds have pulled in a net $1.1 billion says FRC. That is already more than 50 percent than the $743 million pulled in by the category in all of 2005. Why the popularity?

One explanation is that by last year many funds ran through the tax shields created by losses that they recorded in the early aughties bear market and once again handed shareholders an unexpected tax bill for Christmas (albeit a relatively small one in most cases). It was unexpected capitial gains distributions that drove the last mini-boom in tax-efficient funds in 1999 and 2000.

Whatever the reason for the current sales boom, look for more tax-efficient funds to open in 2006 as fund sponsors exploit the demand and the publicity such as that created by today's Wall Street Journal article.

The paper reports that the current crop of tax-efficient funds look a little different than that 1990s crop, which relied on buy and hold strategies. This time the funds are more focused providing current income to investors that is taxed at a favorable rate.

Examples of the 77 funds in the category include the just-launched Dreyfus Tax Managed Balanced Fund and Eaton Vance's Tax-Managed Buy-Write Income Fund a closed-ender that debuted in April.

Those income producing funds are mostly a response to the 2003 tax code changes that sliced the tax rate on dividends to just 15 percent. Those sales may also be a response to the current investing environment in which outsize returns seem to be less of a possibility.  

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