The Japanese open-end fund puzzle

Over the past 2 decades, Japanese mutual funds have consistently and dramatically underperformed risk-adjusted benchmarks. In this article, we examine manager style, tax dilution, and manager inefficiency as three potential explanations for this puzzle. Grouping funds by style of asset management, we find evidence that confirms Cai, Chan, and Yamada's (1997) conjecture that tax dilution contributes significantly to underperformance. We propose a simple instrument to control for this dilution effect. Using this instrument, we find that alphas of Japanese funds are statistically indistinguishable from zero for most types of funds over the period 1982-95.