Investment taxes have a substantial impact on the performance of taxable mutual fund investors. Mutual funds can reduce the tax burdens of their shareholders by avoiding securities that are heavily taxed and by avoiding realizing capital gains that trigger higher tax burdens to the fund’s investors. Such tax avoidance strategies constrain the investment opportunities of the mutual funds and might reduce the before-tax performance of the funds. Our paper empirically investigates the costs and benefits of tax efficient asset management based on U.S. equity mutual funds from 1990-2012. We find that mutual funds that follow tax-efficient asset management strategies generate superior after-tax returns. Surprisingly, mutual funds that generate lower taxable distributions do not underperform other funds before taxes, indicating that the constraints imposed by tax efficient asset management do in practice not have significant performance consequences.
Lower tax and better performance? Awesome.
h.t. Mike P.
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