More Funds Slap Fees on Those Who Bail Out

A growing number of mutual funds are imposing redemption fees on short-term investors in an effort to deter them from churning their shares and wreaking havoc on the funds.

While the absolute number of funds imposing such fees remains modest--311 of the estimated 5,000 stock funds available--the figure shot up nearly 50% between December 1997 and April 1999, according to a study by Boston-based Financial Research Corp.

And the number continues to grow. Recently, the Denver-based Invesco family of funds slapped a 2% redemption fee on five of its funds--including four international portfolios--for shares purchased after May 1 and held for three months or less.

The sharp increase in redemption fees comes as mutual fund investors are showing less patience with underperforming funds.

In the first four months of the year, stock fund redemptions rose 59%, while new purchases increased just 27%.

Short-term traders threaten fund company profits. But their actions also hurt the performance of the funds they flee, analysts note.

Financial Research analyst Mike Evans says funds are often forced to keep a significant amount of cash on hand in case they’re required to meet redemptions--cash that otherwise could be invested in stocks to boost returns.

Those that don’t may be forced to sell stocks if redemptions rise--triggering trading costs and, potentially, taxes.

“The impact can be pretty big,” said Evans, “especially on smaller funds or international funds that might have difficulty getting into and out of certain [illiquid] stocks.”

Typically, funds slap redemption fees on investors who sell shares in the first year after purchasing them. The fees usually range from 0.5% to 2% of the amount sold, the Financial Research study shows.

Some companies use more complicated formulas. Houston-based Bridgeway Fund, for instance, reserves the right to impose a 2% redemption fee on investors who sell shares of either of its two index funds at an inopportune time.

What’s an inopportune time? It’s defined as immediately following a five-day period in which the benchmark Standard & Poor’s 500 index of blue-chip stocks slides 5% or more.

“The last thing you want is a huge rush of people headed to the door right as the market is cratering,” said Bridgeway portfolio manager John Montgomery.

Mutual fund companies aren’t the only ones imposing such fees. Discount brokers such as Charles Schwab charge similar penalties for investors who rapidly sell shares of funds purchased through their mutual fund “supermarkets.”

In general, redemption fees do a good job of deterring investors from selling shares too quickly, said John Markese, president of the American Assn. of Individual Investors, based in Chicago. They also deter so-called market timers from investing in funds in the first place.