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Oakmark Requires Market Timers to Pay Toll

The Oakmark Family of Funds managed by Harris Associates of Chicago is adding a two percent redemption fee to discourage short-term trading for some of its mutual funds. The redemption fee will kick in on August 16 on shares redeemed on five of the fund family's funds within 90 days of their purchase.

The new redemption fee will affect the $1.8 billion Oakmark Select Fund, the $508 million Oakmark Small Cap Fund, the $906 million Oakmark International Fund and the $143 million Oakmark International Small Cap Fund. A brand new fund, The Oakmark Global Fund, that went live August 4, was launched with this same 2 percent redemption fee firmly in place.

But imposing the redemption fee was not an across the board decision for Oakmark. Two of the group's funds, its flagship Oakmark Fund and The Oakmark Equity & Income Fund, will not be imposing this new frequent trading toll.

According to Kelly Arnold, assistant director of marketing for the fund group, both the large cap Oakmark Fund and the balanced Oakmark Equity & Income Fund were excluded because their size allows them to better accommodate frequent trading. But the core message Oakmark is sending to mostly arbitrage-style market timers is crystal clear.

"It's not to discourage these people," Arnold said. Rather it's meant to "encourage investors to invest for the long-term or pay for transactions."

The two percent fee, which will be withheld from hot money trading out of any of the five Oakmark funds, will be returned directly to the fund to offset fees the fund incurs. These fees include processing the redemption and sending a statement, as well as costs associated with the market impact of the funds having to sell securities to realize cash for redemptions and the associated tax consequences, Arnold explained.

The two percent penalty is not an arbitrary figure, said Bill Nygren, portfolio manager of the Oakmark Select Fund. Nygren estimates that Oakmark's costs associated with rogue redemptions typically run between one and two percent of the amounts being liquidated.

"We wanted to be certain it would not try to be punitive," Nygren said. "It's not a way for us to milk short-term traders" as a new revenue stream for the fund, he added. But the Oakmark Funds wanted to find a more definitive way to stem the tide of arbitrage-oriented traders who move their clients into a fund on day one and back out the very next day. "We believe this will result in a reduction of costs the fund has to bear caused by short-term traders," Nygren said.

This is not Oakmark's first attempt at dissuading frequent market-timers. From day one, its funds have discouraged such investors by imposing increasingly stringent limitations, according to Nygren. But not unlike computer hackers, each time timers were able to circumvent the rules and slide in under Oakmark's radar. "No matter how low we set the threshold, they kept getting around that," Nygren said.

When Oakmark set trading limits on trades of $1 million or more, the fund group saw an unusually high volume of trades in the $900,000 range. When that limit was reduced to $500,000, trades in the $400,000 range were numerous. The problem with identifying market-timers with an itch to switch is that they are usually identifiable only after they have executed their trades, Arnold said. The funds' new redemption fee applies as they are leaving.

Still, Oakmark had some concerns about imposing the new redemption fee. Although Nygren warned shareholders of the imminent fee in his June 30 quarterly report to shareholders, Oakmark still worried whether shareholders would accept the idea that the fee was being added in the best interest of long-term shareholders. In addition, Oakmark hoped shareholders would understand that the full amount of the redemption fee was going directly back to the fund itself to offset costs, not to the adviser's coffers. So far, investor response has been uniformly positive, according to Nygren.

Not every fund adviser thinks redemption fees are a good idea, but the practice is becoming more common. According to Morningstar, the Chicago-based mutual fund research company, just under 3 percent or 312 out of the current 10,802 mutual funds now available have some type of redemption fee in place, although some funds that reserve the right to assess such fees may not. "I think redemption fees will be the tip of the iceberg," Nygren said.