Tax-induced Dissimilarities Between Domestic and Foreign Mutual Funds in Italy

Abstract

Using data from Italy, this study investigates whether tax effects can account for differences in return patterns between domestic and foreign mutual funds, and if this dissimilarity translates into performance. The paper presents evidence, based on a unique dataset of 4,178 open-ended mutual funds over the period 1998-2002, that much of the difference between domestic and foreign funds is explained by the different tax systems. The asymmetry between the two groups, due to the fact that domestic funds are obliged to pay taxes on a daily basis while foreign funds are taxed when capital gains are collected, also affects performance, which is probably the reason behind the popular perception that foreigners are more skilful than domestic managers. After controlling for the taxation factor, we show, in fact, that Italian funds are virtually indistinguishable from their foreign counterparts in terms of risk-adjusted returns and fund dynamics.