By Sandra Sugawara
Sunday, October 10, 1999; Page H01

Mutual funds, it seems, are getting choosy about whose money they'll take.

They're looking for a long-term commitment--for better or worse, richer or poorer--and they're warning that fickle investors who stay a little while and then flee for greener pastures may get hit with a big, fat penalty.

Many mutual fund managers look back longingly on the good old days when investors stayed put. "Twenty years ago, the average holding period was seven, eight, even 10 years. Now three years is considered a long holding period. We consider that an insanely short period of time from which to judge a fund's performance," said Brian Mattes, a spokesman for the Vanguard Group of mutual funds.

To try to coax back that kind of patient behavior in investors in its Health Care fund, Vanguard imposes a 1 percent exit fee on "short-term" investors. In this case, "short-term" is defined as cashing out in less than five years.

Five years, of course, predates the rise of the Internet, the surge in online trading, the Asian economic crisis, the Russian economic collapse, day traders and a host of other events that have reshaped financial markets and reshuffled investment winners and losers.

Indeed, few other mutual funds have dared ask for that kind of long-term commitment. The minimum holding periods are generally either 90 days or 180 days.

So far, 354 of the 10,518 mutual funds have redemption fees. That's only about 3 percent of funds, but the number is growing, according to Morningstar Inc., a Chicago-based fund research company.

The reason? Mutual funds say they must protect long-term shareholders from "market timers," professional investment advisers who zip in and out of mutual funds to take advantage of sudden shifts in the market, and from the legions of individuals who are growing more demanding about short-term performance. Both groups yank money out of funds quickly when performance falls, sometimes forcing managers to sell stocks they might want to hold. This raises costs and can have negative tax consequences for remaining fund investors.

"I don't want money from people who intend to trade in less than three months. Those people make it too expensive to the long-term shareholders," said Bill Nygren, portfolio manager of the Oakmark Select Fund, which added a 2 percent exit fee on shares redeemed within 90 days.

Oakmark's exit fees, like most redemption fees, go back into the mutual fund--not to the management company--and are designed to cover the costs of the unexpected redemptions.

But some professional advisers counter that it's unrealistic to long for the old days of passive investing. "I think all of us are having to face a more volatile market these days. Everyone trades. Even mutual fund managers trade," said investment adviser Dave Petersen of Financial Services Advisory in Silver Spring. Petersen said the period he holds a mutual fund on average has been shrinking to about four to five months, and he has at times sold after only a couple of weeks.

Fund managers question whether such rapid turnover is actually smart investing. Financial advisers reply that it's their only protection in a market that swings widely. After one manager chastised investment adviser David Lucca for pulling a large sum of money out of his fund, which was not performing well, Lucca responded: "How long am I supposed to wait before I move? Should I lose 10 percent of my client's money before I move? Twenty percent? Thirty percent?"

"We manage $90 million held by individuals, mostly retirees. They don't have another 30 years to make back their money," said Lucca, a partner in Rhoads Grunden Lucca Capital Management in Lancaster, Pa., and president of the Society of Asset Allocators and Fund Timers.

Redemption fees are not new. Vanguard Health Care has had an exit fee since its inception in 1984. That original fee was 1 percent for those who pulled out before one year.

Likewise, market timers are not new. For years, a small number of investors have moved into and out of funds to try to take advantage of market moves. What is different now is that investors across the board seem to be focusing much more on the short term, Mattes said. "Maybe it's a sign of the hot market we're in," he said.

A bull market that has fixated the public on stocks, instant investment advice for anyone via the Internet, technology and services that make it easy to buy and sell, and media reports of phenomenal returns have all contributed to this short-term mentality.

Lucca acknowledges this makes a fund manager's job tougher: "I move $4 [million] or $5 million around, not $12,000, so I can imagine the feeling of panic that occurs when they see big chunks of money like that moving around."

"Hyper-market timers," as Lucca calls them, try to take advantage of daily movements or factors such as the time differences between markets, but he and most financial advisers do not engage in such practices, he said.

One example cited by fund managers: Market timers can exploit the time difference to make a bet on overseas markets using mutual funds. The performance of the U.S. stock market is a major influence on foreign stock markets, which generally open hours after the New York Stock Exchange has closed.