Mutual Funds’ Aversion to Tax-avoiding Firms: An Anomaly?

We document evidence that mutual funds, on average, are averse to investing in tax-avoiding firms, which seems anomalous given mutual fund managers’ incentive structure. Our results remain unchanged when we address endogeneity concerns using several methods, including identification through instrumental variables, difference-in-differences, and matching methodologies, and after running a litany of robustness checks. We also find that poor-performing mutual funds reduce their ownership in tax-avoiding firms, a result inconsistent with both fund managers’ incentive and diversification motives. Furthermore, mutual funds’ aversion to tax-avoiding firms persists regardless of the mutual funds’ investment horizons.