A client of yours has been investigating a particular mutual fund. She mentions that she saw a blurb on the Internet that the fund has had net redemptions over the past 6 months and asks you to explain how that might affect the fund's performance. You should explain that:
I. this is a good thing because now, with less money to invest, the fund's adviser is able to be more selective.
II. performance will probably suffer because the fund's adviser will have to sell positions prematurely in order to meet redemption requests.
III. this would be a good time to buy because the supply of shares exceeds the demand.
IV. many of the fund's expenses are relatively fixed so with fewer shares outstanding to share the cost, the expense ratio will probably increase.
A) II and III.
B) I and IV.
C) I and III.
D) II and IV.
Answer: When a fund has net redemptions, it means that less money is coming in than is going out. In order to meet those redemptions, the fund's manager will either have to sell securities that they planned to hold on to, or maintain more assets in cash (which generally will return less than other investments). As the number of outstanding shares is reduced, the fund's fixed expenses are borne by fewer shares leading to an increased expense ratio.