Investors who skip blithely from fund to fund, beware. More funds are imposing redemption fees to trip up those who are fleet of foot, fund experts say, and the fees are carrying nastier stings.
Unlike back-end loads, or deferred sales charges–typically used to pay brokers–redemption fees are returned to the fund’s asset base. They average 1 percent of the assets being redeemed and are intended to discourage short-term players, such as market timers or those who simply change their minds a lot.
The fees, however, are usually not imposed for long. According to Lipper Analytical Services, a research firm based in Summit, N.J., the average redemption fee is in effect for about seven months from the date of purchase. After that, investors can get out without paying a toll.
Why are more funds considering redemption fees? Talk to Mark Coffelt, manager of the high-flying Texas Capital Value and Growth fund. Last October, fair-weather investors yanked 20 percent of his fund’s assets in just three days.
That forced him to sell stocks, many at a profit, resulting in capital gains on which the remaining shareholders had to pay unexpected taxes. “They got whacked,” Coffelt said.
Even those holding funds in tax-deferred accounts can be hurt in such circumstances because the manager can be forced to sell into a market that does not want to buy. “The timers cash out just as the liquidity in the market is drying up,” said Coffelt, who is now considering imposing a redemption fee. “They are roaches in the kitchen.”
Among the fund companies that are upping the redemption ante is Fidelity Investments, the industry giant. A number of Fidelity funds already carry redemption fees of up to 1.5 percent, typically for redemptions within 90 days of purchase. But the new Fidelity Small Cap Stock fund charges 3 percent, and the fee is levied if an investor skips within the first three years.
Does that sound like a long time to stick around? Consider the five-year tenure required by tax-managed funds from the Vanguard Group, which impose a redemption fee that slides from 2 percent to 1 percent.
And some funds are imposing fees regardless how long investors stay. The Oberweis Micro-Cap and Oberweis Mid-Cap funds charge a modest 0.25 percent fee whenever an investor redeems shares.
Oberweis Asset Management president James Oberweis said he fights “a constant battle” to keep market-timers out of the company’s Emerging Growth fund, too, and has considered applying a fee there as well.
Some of the rules are a mite tricky. At Bridgeway Capital Management, both Bridgeway Ultra-Large 35 Index and Bridgeway Ultra-Small Index come with permanent redemption fees, but with a twist: The 2 percent toll will be assessed, at the fund’s discretion, only if an investor sells after the Standard & Poor’s 500-stock index has fallen by 5 percent in the five previous trading days.
“You have the right to redeem your shares,” said Bridgeway president John N.R. Montgomery. “But if you’re pulling your money out just at the time when it will be most painful for shareholders who remain in the fund, well, we don’t want you to do that.”
Permanent fees are perhaps most common among emerging-markets funds, more than 20 percent of which have a redemption fee of some kind, according to Morningstar Inc., the Chicago financial publisher.
With these funds, the fees serve a dual purpose. They discourage timers and compensate other shareholders for what Vanguard spokesman Brian Mattes called “extraordinarily high costs of trading in these markets.”
“There are taxes, stamp fees, often really huge bid/ask spreads–it can be very expensive when new money comes into the portfolio,” Mattes said.
To counter that expense, some funds with high trading costs but without redemption fees hit you up on the front end. Five Vanguard funds, for example, charge “purchase fees” that range between 0.5 and 1 percent. Charles Schwab now charges a flat fee of at least $39 in its One Source program for sales of shares held less than 90 days.
Fickle investors take note: One way or another, you’re going to pay to play.
