- The Washington Times - Wednesday, April 13, 2005

It could be the only fee you are happy to see your mutual fund charge.

Redemption fees are widely considered a good thing for long-term investors because they help mutual funds recoup trading costs incurred by those who hold shares for only a short time. A recent decision by the Securities and Exchange Commission confirms regulators’ commitment to the use of redemption fees to combat market-timing in mutual funds, but some still question the legitimacy of these exit charges.

It’s not that there’s anything wrong with short-term trading, or even market timing. But mutual funds have evolved as a vehicle for long-term investors, which makes them an inappropriate vehicle for the short term. At the heart of the problem, costs imposed by frequent traders are borne disproportionately by long-term shareholders, said Mercer Bullard, chief executive of Fund Democracy, a fund shareholder group, and a securities law professor at the University of Mississippi.

“As a general matter, investors should be pleased with the existence of redemption fees, because it reduces the fund’s overall operating costs,” said Mr. Bullard, a former assistant chief counsel at the SEC. “You do not want market timers in your fund because they drive up your costs. In a fund designed for long-term investors, market timers are your enemy, not your friend.”

In fact, if a fund charges a hefty redemption fee, Mr. Bullard said, it should serve as a clear warning that it’s not an appropriate investment for anyone with a short-term horizon.

Redemption fees vary from fund to fund. Typically they are charged when an investor sells a position held for less than a period of time specified in the prospectus, usually ranging from a few days to six months, or in rare cases, several years.

Last month, the SEC voted to permit, but not require, mutual funds to impose redemption fees of no more than 2 percent of the value of shares redeemed if they find it necessary to recoup the costs associated with short-term trading. Under the rule, the fund itself would retain the proceeds — meaning the fees go back into the pot held by other shareholders rather than to the fund’s manager. The rule does not apply to money market funds and exchange traded funds, which track indexes but trade intraday like stocks.

Many traditional mutual funds already have adopted redemption fees to prevent market timing; Fidelity Investments has been using them since 1989.

Not everyone agrees redemption fees are such a great idea, of course. Among its detractors is the National Association of Active Investment Managers, a nonprofit group of registered investment advisers who use market timing strategies to manage assets invested in mutual funds. Peter Mauthe, a member of NAAIM’s board of directors and the chief operating officer of Rhoads Lucca Capital Management, said the people he has seen most often hurt by redemption fees are small investors — the very group they are supposed to protect.

“The only way an investor will never have to sell a fund for the next six months is by asking them to be clairvoyant,” Mr. Mauthe said. “There is no other investment in the U.S. an average investor can go into that is subject to market fluctuations that has a lockup period. And that is what a redemption fee is trying to do.”

Part of the problem is that there is no exemption in case of unforeseen events, such as a death, a divorce, a job loss or some other crisis, such as the turmoil that followed the terrorist attacks of September 11, 2001, Mr. Mauthe said.

If redemption fees must be used, he said, they should be a measure of last resort rather than a measure of easy implementation. As an alternative, his group advocates the use of fair-value pricing to curtail abuses related to time-zone differences in international funds; and the use of tax identification data to track abuses in domestic funds.

Fidelity, like most mutual fund companies, processes sales of shares on a first-in-first-out basis, meaning an investor who makes regular contributions but rebalances quarterly is unlikely to be subject to redemption fees for making modest changes to a long-term portfolio.


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