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Tax efficient investing

Janie Casello Bouges, University of Massachusetts Amherst


Taxation has permeated several areas of financial research including capital structure, dividend policy, mergers and acquisitions, asset allocation and investment policy. This paper consists of three essays that examine matters of taxation with respect to various investment instruments. The first paper looks at the relationship between after-tax mutual fund returns and the various mutual fund characteristics that affect those returns. Dickson and Shoven (1993) showed how capital gain realizations can significantly reduce after tax returns. Despite this finding, Bergstresser and Poterba (2002) provide evidence to show that some investors prefer not to postpone capital-gain realization. They document that funds that don't pass through capital gain distributions, and thus increase their embedded capital gains, experience smaller gross cash inflows and gross cash outflows, ceteris paribus, than funds without large capital gain overhangs. Barclay, Pearson and Weisbach (1998) present a model in which these unrealized gains in the funds portfolio increase expected future taxable distributions, and thus increase the present value of a new investor's tax liability. This paper, in part, is an extension of these works. It seeks to determine what factors trigger these future taxable distributions. The second paper shows how the calculation, as required by the SEC, of after-tax returns distorts after tax returns for mutual funds that make the I.R.C. section 853 election. It also shows that all rational fund managers should make the I.R.C. section 853 election. It examines the characteristics of funds that make the 853 election and shows that, ceteris paribus, electing funds produce superior, after tax returns. The third paper examines the impact of regulation on after tax returns. Traditionally, the SEC has promulgated regulations that limit hedge fund investing to wealthy, sophisticated investors. Recently, however, the market's desire for hedge fund exposure for the average investor has prompted lawmakers to pursue more stringent regulation of hedge funds. One goal of this regulation is to bring more parity between mutual funds and hedge funds. The purpose of this paper is to review the various legal and tax regulations that impact hedge fund and mutual fund returns and to suggest strategies to implement current regulations in such as was as to make hedge funds as tax efficient as other types of investments with similar return patterns.

Subject Area


Recommended Citation

Bouges, Janie Casello, "Tax efficient investing" (2005). Doctoral Dissertations Available from Proquest. AAI3179858.