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Revealing Redemption Rates


So far, dozens of funds from 19 mutual fund companies have been implicated in the fund industry scandals. But even if your funds have avoided the taint, the investigations are far from over.

Are any of your funds targets of market timers? There's an easy way to spot funds that may be at risk: Calculate a fund's redemption rate, which tells you how long shareholders stick around. This figure, which can be derived from data in the fine print of fund disclosures, can be "a very good indicator" that a fund is allowing market timers in, says John Bogle, founder of Vanguard Group.

Although market timing isn't illegal, many companies have policies that discourage it, and some got in trouble for turning a blind eye to their own rules. Indeed, frequent trading siphons profits -- by one estimate, up to $1 billion a year -- from buy-and-hold investors. Why? To cash out traders, managers are often forced to sell securities, incurring brokerage and tax bills that get passed on to remaining shareholders. In addition, quick-hit investors are entitled to their share of the fund profits -- even if they dart in and out so quickly that the fund manager has no time to put their cash to work. "Managing money is hard enough, but if assets are pouring in and out, it's that much harder," says Don Phillips, managing director of mutual-fund researcher Morningstar.

To find a fund's redemption rate, you need to get its most recent annual or semiannual report. (Funds are required to report every six months.) For instance, look at the most recent annual report from Massachusetts Investors Growth Stock Fund, one of 11 funds run by Boston-based MFS (SLF) that regulators say allowed illicit market timing. (On Feb. 5, the management company announced a $225 million settlement with regulators, including New York Attorney General Eliot Spitzer and the Securities & Exchange Commission over the allegations. MFS neither admitted nor denied the charges.) The report is available on the company's Web site, mfs.com, and also at the SEC site, sec.gov. Annual and semiannual mutual-fund reports are coded with "N-CSR."

DOING SOME DIGGING. Go first to the section labeled "Notes to Financial Statements," and then look for the table titled "Shares of Beneficial Interest" near the back of the section. The first piece of information to locate is the dollar value of the fund's redemptions -- called "Shares Reacquired" on MFS's disclosures. For the Massachusetts Investors Growth Stock Fund, the total for all the fund's share classes is about $10.6 billion for the year that ended Nov. 30 -- the most recent disclosure available.

Next, compare that with the fund's average assets during the same period. This number isn't published, but you can find the data you need to derive it in the "Statements of Changes in Net Assets" in the report's "Financial Statements." Simply average the fund's $10.265 billion in assets at the beginning of the period with the $11.08 billion it held at the end. The result: $10.6725 billion. Next, divide the fund's redemptions of $10.6 billion by its average assets of $10.6 billion, and convert the result to a percentage by multiplying it by 100. In this fund's case, the redemptions and average assets are about the same, so the redemption rate is 100%. Or put it this way: It's as if all the fund's investors had turned over their shares in the course of the year.

When it comes to redemption rates, what's too high? Amy Arnott, director of securities analysis at Morningstar, says you should be concerned when redemptions at equity funds are over 40% of average assets. That's around the industry's five-year average, when exchanges among funds within the same fund family are included, according to Bogle.

Although a high redemption rate isn't "an automatic indication that there was market timing going on in a fund," Arnott adds, it's a red flag. Two funds with high rates are AIM International Growth and ING International, and a third, MFS Emerging Growth, was one name in the regulators' case against MFS. Spokesmen for the funds declined to comment.

Redemption rates will be coming down. In part, that's because of regulatory pressure and because many fund companies are imposing fees -- 1% or 2% -- on withdrawals made within three months of investing. Bogle's data show the average has already declined -- from 41% in 2002 to 31% in 2003. Rather than assume your funds are benefitting from this trend, get the data and do the math. Why should you be sharing your profits with market timers? By Anne Tergesen


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