Gallery:Step 4|Step 4: Time Pickers

Redemption Rates Not a Good Tool for Measuring Mutual Fund Holding Periods

Gallery:Step 4|Step 4: Time Pickers

Using mutual fund redemption rates to determine investor holding periods isn't kosher, according to recent research by Investment Company Institute (ICI). The problem with redemption rates, which measure annual fund redemptions as a percentage of average assets, is that a small minority of high-turnover shareholders can significantly jack up a fund's redemption rate. This scenario can potentially skew the holding period of the typical fund investor if it is calculated using redemption rates.

Consider this hypothetical situation supplied by ICI:

All of the shareholders in Fund A redeem all of their shares once every seven years. Let's assume that the shareholders cooperate to produce nice clean numbers, and 1/7 of the fund's assets is redeemed annually. Fund A has an annual redemption rate of 14%.

Investors in Fund B behave a little differently. Ninety-eight percent of the shareholders, which also hold 98% of the fund's assets, have the same annual rate (14%) as the investors in Fund A. However, the remaining 2% of Fund B shareholders are active traders, and make 12 redemptions each year, at an annual rate of 1,200%. Fund B has a total redemption rate of 38%, twice that of Fund A.

Using Fund B's redemption rate would lead one to conclude that the typical investor redeems all fund shares in less than three years, although a large majority of the accounts turn over at a much slower rate.

According to ICI, research demonstrates that most mutual funds have investors that behave like the ones in Fund B. Most investors redeem shares infrequently, and a very small percentage are active traders that have high turnover.

Note: The hypothetical example assumes each investor holds the same amount of the fund's assets, and that redeemed assets are replaced by sales of new shares.

Rating Mutual Fund Company Online Customer Service

A new report by consulting firm kasina gives mixed messages concerning the state of online customer support for mutual fund investors. According to the study, 84% of mutual fund companies accept inquiries via the web or email. However, only 46% of mutual fund companies that accept electronic inquiries respond to all of them. The report also found that emails are 18% more likely to generate a response if sent on Monday versus Friday.

“We’ve seen a considerable improvement in fund company customer service on the web over the past two years," said Michael Sellitto, a consultant at kasina. "In 1998, only 8% of mutual fund company responses to e-mail were within two days. Today, that number has jumped to 87%. Nevertheless, there is still significant room for improvement. Mutual funds must embrace technologies such as artificial intelligence, live online chats, and customer relationship management software to efficiently build a better relationship with current and prospective shareholders.”

The Vanguard Group recently announced a partnership with Financial Engines (founded by 1990 Nobel Laureate in Economics Bill Sharpe) to offer free online advice for investors. Vanguard said the Internet can be used to make investor education more efficient, and help keep fund expenses at a minimum.