A higher mutual fund fee isn’t automatically a negative, professor says
Don’t turn your back on mutual funds that charge redemption fees, says Michael Finke, associate professor at Texas Tech University. His research says such fees, up to 2 percent for pulling out of a fund before a certain period, discourage short-term traders from jumping in and out. That kind of trading drives up costs, hurting long-term investors. He says the effect is more pronounced the higher the redemption fee and the longer its duration.
■ So redemption fees are not only not bad, they actually create better performance? One of the biggest problems that redemption fees have is perception by investors. They have a marketing problem. They are not so much a fee as a transfer from short-term to long-term investors. If you’re a long-term investor, redemption fees are good for you.
■ It’s like a cover charge to keep the riffraff short-term investors out? It’s like a cover charge but it’s given back to you as a drink coupon.
■ The reason short-term trading hurts is because it forces funds to carry more cash in anticipation of redemptions? One of the biggest problems is there is a cost to holding a lot of cash. But there are also tax implications, and there are trading costs related to trading securities. One of the trading costs that a lot of investors don’t think of is having to sell a bunch of securities in a thinly traded market. In other words, if the fund manager is holding onto a lot of shares of a very small firm or shares of firms that don’t trade frequently, having to dump a large number of shares is going to have a big impact on the price of that stock.
■ Are fund families imposing redemption fees on the funds that would most benefit from them? I don’t think there is a lot of knowledge even among fund families about when redemption fees are most useful. What happened in 2004 and 2005 was that a lot of fund families initiated redemption fees as a way of showing investors that they were actually doing something about the mutual fund market-timing crisis. What we’re seeing now is a lot of fund families considering getting rid of those redemption fees. Our research would suggest that if they want to get rid of redemption fees, they should focus on the funds that are most liquid where they don’t offer as much of an advantage.
■ Should we be preparing for a time when every fund charges a redemption fee?
Most investors are not that savvy. The savvier investor is going to consider this. But unless the information about the benefit of redemption fees becomes more broadly known, I think the majority of investors will see them as another cost.
■ So the takeaway is that a good fund-picking strategy is to look at the ones with the highest and longest duration for redemption fees?
Stan Choe is an Associated Press business writer.