Redemption Fees: Reward for Punishment

What is it about?

Short-term redemption fees have become increasingly prevalent amongst mutual funds. Mutual funds impose redemption fees with the intent of maximizing the wealth of mutual fund shareholders through discouraging them from engaging in frequent trading activity. This paper empirically analyzes if and how redemption fees achieve this goal. We find that mutual funds with redemption fees outperform their counterparts by 1.0 to 1.4 percent a year. Moreover, performance increases by 0.5 to 2.4 percentage points a year following the initiation of a redemption fee such that the difference in performance between the two groups of funds is indeed attributable to the fee. We find that the fee improves performance through changing portfolio characteristics. Most notably cash holdings decrease by 77 to 102 basis points after fee initiation.

Featured Image

Why is it important?

Mutual funds with short-term redemption fees outperform their counterparts by 1.0 to 1.4 percent a year. Long-term investors should prefer mutual funds with redemption fees over those without redemption fees. Mutual funds seeking to maximize the risk-adjusted performance that they deliver to long-run investors should consider imposing a redemption fee.