As ever more investors shift their mutual fund holdings according to their short-term performance, firms are increasingly charging redemption fees, according to Financial Research Corp., a mutual fund research and tracking firm in Boston.

The number of funds charging redemption fees has increased to 311, as of the end of April, up 49 percent from 209 funds that charged such penalties in 1997, said FRC.

FRC defines a redemption fee as an additional charge a mutual fund company imposes to dissuade investors from withdrawing their money from a fund within 12 months of investing in it. Redemption fees range from 0.5 percent to two percent of the value of holdings.

Early withdrawal of money from a fund is costly to the fund, FRC said in a report released in May. It forces a portfolio manager to hold a large position of the fund in cash and to sell positions earlier than desired. This has a negative effect on performance and can be particularly difficult for a portfolio invested in less liquid stocks, FRC said. In addition, the higher turnover of stocks increases the funds' management fees, which also dampens performance.

The primary reason mutual fund companies are turning to redemption fees is the rise in shareholders trying to "market time" their mutual fund holdings, FRC said.

"A redemption fee can make it more costly for a timer to use the fund and thus eliminate the portfolio from their selection screens," FRC said.

Fifty-seven percent of the 311 funds that charge a redemption fee are domestic equity funds, FRC said. The next largest group - 30 percent of funds that charge redemption fees - are international/global equity funds, according to FRC.

FRC also found that funds sold directly without a load are more prone to turnover.

"The need for a redemption fee is much greater for a direct-marketed fund as opposed to a broker-sold fund, since the load is an effective deterrent to an investor trading a fund soon after paying a sales charge," FRC said in its report. As a result, 66 percent of the funds that carry a redemption fee are marketed directly. Twenty-two percent of those with redemption fees are sold through wholesalers, six percent via the institutional channel, five percent through a captive sales force and one percent through banks, the company found.

FRC concluded that the number of funds charging redemption fees will grow.

"As investors become increasingly more knowledgeable and online brokerage services proliferate, [making] it easier to trade funds, the issue of market timing will accelerate," FRC said.

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