Do Redemption Fees Hurt Long-Term U.S. Mutual Fund Investors?

Abstract

Redemption fees have been proposed as a way to curb trading on stale prices by short-horizon investors to make profits at the expense of long-horizon investors who only trade to rebalance back to their optimal allocations. For redemption fees to be a viable device to curb stale price trading, they must have a negligible impact on the utility of these long-horizon agents. To assess this impact, we examine how the imposition of redemption fees affects the utility of long-horizon agents, allowing for the possibility that the long-horizon investors are rebalancing to take advantage of return predictability. Restricting the imposition of the fee to sales of shares purchased within 6 months, the utility cost of the redemption fee is never more than 0.12% of wealth when returns are i.i.d. and never more than 0.54% of wealth when returns are predictable. These utility costs are very small. For redemption fees to be a viable device to curb stale price trading, they must also be large enough to deter short-horizon investors from taking advantage of the stale prices. We find that they are, based on the documented profitability of such strategies, at least for the typical domestic fund and for the typical large capitalization domestic fund.