Recent empirical evidence has suggested that the Japanese mutual fund industry has" underperformed dramatically over the past two decades. Conjectured reasons for" underperformance range from tax-dilution effects to high fees, high turnover and poor asset" management. In this paper, we show that this underperformance is largely due to tax-dilution" effects, and not necessarily to poor management. Using a broad database of funds which" includes investment trusts closed to new investment, we show that once an instrument for the" time-varying tax-dilution exposure is included in a factor model, there is little evidence of poor" risk-adjusted performance. A style analysis of the industry demonstrates that managers appear to" pursue tax-driven dynamic strategies.