OPEN-END MUTUAL FUNDS AND CAPITAL-GAINS TAXES

Despite the fact that taxable investors would prefer to defer the real ization of capital gains indefinitely, most open-end mutual funds regu larly realize and distribute a large portion of their gains. We presen t a model in which unrealized gains in the fund's portfolio increase e xpected future taxable distributions, and thus increase the present va lue of a new investor's tax liability. In equilibrium, managers intere sted in attracting new investors pass through taxable capital gains to reduce the overhang of unrealized gains. This model contains a number of empirical predictions that are consistent with data on actual fund overhangs. (C) 1998 Elsevier Science S.A. All rights reserved.