Blog - Investing Notes
April 23, 2008 - Redemption Fees Signal Mutual Fund Outperformance?
Should investors avoid mutual funds that charge redemption fees, or is there
a good reason to accept this explicit hit to liquidity? In other words, do these
fees protect underperforming fund managers or long-term investors? In their
recent paper entitled "Redemption
Fees: Reward for Punishment", David Nanigian, Michael Finke and William
Waller study the impact of short-term redemption fees on long-term fund performance
based on fee size and duration (effective time interval of the redemption fee
after purchase). Using monthly after-tax returns for a very large sample of
open-end US equity mutual funds over the period July 2003 to May 2007, they
conclude that:
- The percentage of U.S. equity mutual funds charging a redemption fee increases
from 3.9% in 2003 to 14.6% in 2007.
- Among funds imposing a redemption fee, the proportion with fee durations
one year or longer falls from 29% in 2003 to 5.5% in 2007, while the proportion
with fee duration one month rises from 14.4% to 48%.
- Funds with redemption fees tend to be small in size, have low expense ratios,
favor value over growth and lean toward small capitalization stocks.
- Redemption fees mostly indicate fund outperformance, especially for fee
durations greater than one month, as follows:
- Funds with small redemption fees and long
durations outperform funds with no redemption fees by about 3% per
year.
- Funds with large redemption fees and long durations outperform
funds with no redemption fees by about 1.2% per year.
- Funds with small redemption fees and short
durations outperform funds with no redemption fees by about 0,9%
per year.
- Funds with large redemption fees and short durations underperform
funds with no redemption fees by about 1.1% per year.
- Funds that levy the full 2% fee allowed
by the SEC tend to underperform funds with comparable durations
but lower fees.
In summary, properly structured mutual fund redemption fees tend to protect
long-term investors by penalizing frequent traders. Small redemption fees of
long duration are optimal for long-term investors.
For related research, see Blog
Synthesis: Mutual Funds and Hedge Funds.