A Fee That Can Actually Make You Money?

Mar 17, 2010 by Cory Chandler

(PhysOrg.com) -- Short-term redemption fees protect and boost returns for long-term mutual fund investors.

Wait … what? A penalty fee that can actually make you money?

Short-term redemption fees could boost returns for mutual fund investors by as much as 3.27 percent a year, according to researchers in Texas Tech University’s Division of Personal Financial Planning.

The three authors of Redemption Fees: Reward for Punishment, presented at the 2010 Morningstar Ibbotson Conference in Orlando, Fla., found that fees that penalize investors for selling a fund before a certain period of time discourage investors from trading in and out of mutual funds, protecting long-term investors.

Redemption fees have enjoyed a recent surge in popularity, the study noted; the proportion of funds employing such fees more than tripled following the mutual fund market timing scandal of 2003.

Authors included Michael S. Finke, associate professor of personal financial planning, and David Nanigian of the Texas Tech College of Human Sciences and William Waller of the Kenan-Flagler Business School at University of North Carolina at Chapel Hill.

“Mutual funds initiated redemption fees mainly to show investors that they were serious about reducing abusive short-term trading practices,” Finke said. “The fees didn’t improve performance in funds that invested in larger, more liquid securities. However, micro-and small-cap funds saw a significant increase in performance after they imposed the fees.

“Unfortunately, redemption fees have a marketing problem since they are labeled a fee instead of what they actually are - a transfer from short-term to long-term investors.”

They found that short-term redemption fees benefit funds that invest in illiquid securities, or financial assets that are not easily sold or exchanged for cash.

They also noticed a link between the size of the penalty and the length of time investors are required to hold shares. Those funds that charged the maximum 2 percent penalty allowed by law and that imposed a holding period of more than two months produced the greatest returns over those funds that didn’t charge penalties.

“Many investors don’t appear to be paying attention to redemption fees when making fund choices,” Finke said. “Unfortunately, we’re already beginning to see many fund families eliminating them. Our research shows that long-term should seek out funds that impose fees on short-run redemptions.”

Explore further: How limiting CEO pay can be more effective, less costly

More information: To view the entire article, visit papers.ssrn.com/sol3/papers.cfm?abstract_id=1118959

Related Stories

Recommended for you

College rankings go under the microscope

2 hours ago

Parents, students and admissions officials have combed through college and university rankings for years. However, education researchers have largely ignored the controversial lists. That's about to change, according to a ...

A call to US educators: Learn from Canada

16 hours ago

As states and the federal government in the U.S. continue to clash on the best ways to improve American education, Canada's Province of Ontario manages successful education reform initiatives that are equal parts cooperation ...

Devices or divisive: Mobile technology in the classroom

Apr 17, 2015

Little is known about how new mobile technologies affect students' development of non-cognitive skills such as empathy, self-control, problem solving, and teamwork. Two Boston College researchers say it's ...

User comments : 0

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.