Despite the fact that taxable investors would prefer to defer the realization of
capital gains indefinitely, most open-end mutual funds regularly realize and distribute
a large portion of their gains. We present a model in which unrealized gains in the
fund's portfolio increase expected future taxable distributions, and thus increase
the present value of a new investor's tax liability. In equilibrium, managers interested
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.