An increasing number of U.S. mutual funds are beginning to penalize investors who try to time changes in market direction by fast trading in and out of funds.
More than 310 funds charge "redemption fees" to people who pull out their money within a month or up to one year after making an investment. That number has risen 50 percent since the end of 1997 and the total will continue to increase, company executives said.
Funds worry that the recent increase in short-term investing, buoyed by day-traders using the Internet, could bring a fast depletion of a fund's assets and upset its investment routine.
"We are considering redemption fees," said Terrence Dunne, director of marketing at Harris Associates LP, manager of the Oakmark mutual funds. "We're concerned about the day-trading of some of our funds, particularly our international funds."
Fund managers say redemption fees--typically 1 percent to 2 percent of the money withdrawn--help limit cash outflows that can force them to sell securities at unfavorable prices and simultaneously increase their trading costs. The fees are reinvested in the funds, as opposed to going to the fund management companies.
Invesco Funds Group Inc. in August will start charging redemption fees of 2 percent for several funds, including Invesco High Yield, to investors who pull out money in less than three months.
Charles Schwab & Co., the world's biggest Internet broker and the seller of more than 1,000 mutual funds, now requires that investors hold their fund shares for at least 180 days, up from 90 days before, if they want to avoid redemption fees. The fees are paid to San Francisco-based Schwab to cover administrative costs related to the transactions.
"We want to make sure people are buying mutual funds for the purpose they're designed, and that's longer-term investing," said Jeffrey Lyons, Schwab's senior vice president in mutual fund marketing. "Mutual funds aren't short-term trading vehicles for market-timers."
Skeptics doubt the redemption fees are large enough to scare away traders and say there's no foolproof way to quantify whether the fees help funds maintain their performance.
"The fees work to a limited degree, but when the markets are volatile, a 1 percentage point penalty isn't much of a deterrent when you think you're going to lose 20 percent of your money," said Russel Kinnel, a senior analyst at Morningstar Inc., an industry research firm.
The fees that are most effective are those that exceed 1 percent of assets and are designed to keep investors in the funds for longer than a year, Kinnel said.
If the fees don't discourage speculators, at least they will help cover the costs of in-and-out trading, the funds say. Of the $3.27 trillion invested in stock funds, 1 percent is in the hands of investors with short-term trading goals, according to Strategic Insight LLC, an industry research and consulting firm. One percent doesn't seem like much, but it means that $33 billion is moving around and some funds could get hit hard by redemptions.
Fidelity, the biggest U.S. fund company, was among the first to use redemption fees starting in the late 1980s. Today, Fidelity charges redemption fees for 77 of the firm's 166 retail mutual funds.
"We've found the fees do a good job covering the costs associated with short-term trades," said Jessica Johnson, a spokeswoman at Fidelity Investments.
Boston-based Fidelity, for instance, said its Small Cap Selector Fund raised $882,960 in redemption fees during the fiscal year ended April 30, 1998, to help offset the trading costs caused by the shareholder withdrawals.
Vanguard Group, the second-biggest fund company after Fidelity Investments, uses several policies to limit short-term trading. The company has redemption fees on about a dozen funds that range from 1 percent to 2 percent of what's withdrawn.
The company doesn't allow investors to exchange shares from one of its 20 index funds to another over the telephone. Investors must instead put their exchange requests in writing. Vanguard also limits exchanges in the same fund to two per year and the exchanges can't occur within a 30-day period.
Vanguard allows investors to sell shares over the phone but keeps a watch out for speculators.
"We monitor the trading activity of our shareholders and we'll issue warnings when the activity is deemed excessive," said John Woerth, a Vanguard spokesman.
Vanguard has even closed the accounts of some fast-trading customers. "We have on occasion decided against accepting investments from some individuals," Woerth said.