For fund investors, new management can bring changes in investment strategy and the potential for improved performance. But it can also mean higher taxes for investors who hold a fund in a taxable account. That's because a new manager, eager to put his or her stamp on a fund, often will sell unwanted holdings inherited from a predecessor. Such sales can generate capital gains, which are then distributed to individual investors who are responsible for paying taxes on them.
This is a good example of how heavy turnover in a mutual fund portfolio can have negative tax consequences for investors. A mutual fund is a "pass through" security for tax purposes. This means that if the fund portfolio has capital gains on the sale of some of its securities (that aren't offset by other capital losses), those gains are passed along to the mutual fund holder as a taxable distribution. Mutual funds typically make distributions of capital gains and/or dividends a couple of times a year.
Here's an example of how distributions work. Let's assume that a mutual fund has a net asset value (NAV) of $10 per share, and an investor invested $10,000 in the fund (i.e. 1,000 shares) on September 1. The fund declares a $2 per share capital gains distribution on October 1. So, the investor has $2,000 of capital gains (i.e. $2 per share times 1,000 shares) to declare on his income taxes for that year. As soon as the distribution is declared, the NAV of the fund drops to $8 per share (the original $10 less the $2 distribution). If the investor chooses to reinvest the proceeds, it would buy 250 additional shares (i.e. $2,000/$8). So, the investor now has 1,250 shares valued at $8 each, for a value of $10,000.
From an "accounting" standpoint, dividend or capital gains distributions don't change the value of an investors portfolio - they merely end up in the investor having more shares with a smaller NAV. But they do cause a "taxable event".
When the portfolio of a mutual fund changes, it usually results in capital gains distributions (after all, if a fund sells its winners, it has profits, and they must be distributed). This is one good reason for investing in index funds. The portfolio in an index fund typically only changes when a stock is added or subtracted to an index (and this is a relatively rare event). So, even if the management of an index fund changes, the index doesn't, and there is no change in the portfolio.
Yet another reason to go with index funds.