Redemption Fees: Reward for Punishment

Abstract

Short-term redemption fees may prevent investors from frequently trading in and out of mutual funds, which results in an implicit wealth transfer from long- to short-term fund investors. This paper studies determinants and implications of short-term redemption fees. We find that the probability of redemption fee initiation is increasing in operating expenses and recent returns and decreasing in the liquidity of portfolio stockholding. In the cross-section of mutual funds, those with redemption fees outperform their counterparts by 1.0 to 1.4 percent a year. Moreover, we observe this increase within a given fund such that the estimate is not simply a proxy for managerial quality. Instead, portfolio characteristics change with the introduction of a redemption fee. Most notably cash holdings decrease by 77 to 102 basis points after fee initiation.