So, we've seen the damage, but how can redemptions harm fund shareholders who elect to stick around? When a mutual fund is hit with a high rate of redemptions, the manager has a difficult task because most funds don't hold enough cash to meet sizable redemptions, so they must sell stocks to return cash to shareholders.
Take Marty Whitman, manager of Third Avenue Value, who has built a great long-term record thanks to his expertise in distressed investing. Whitman has reported that many of his stock sales in recent months have been necessary to meet redemptions, and he's had to keep about 7% of the fund's assets in cash so that he can meet redemptions without selling stocks at extremely depressed prices.
So, redemptions pose opportunity cost risk, because managers like Whitman may be selling shares of stocks that they think are poised for a rebound--just to meet redemptions.
It also does a good job telling investors who have money in funds what information they should expect to get from managers:
Your fund should be explaining to you, through shareholder letters and semiannual and annual reports, how it is managing redemptions, but sadly, most funds have been mum in the recent market crisis. Many managers do not explain much about their fund's inner workings beyond quarterly performance, let alone the effect of redemptions in their letters.
Among international stock funds, Marty Whitman continues to be the best example. Aside from talking in-depth about individual holdings and putting the current environment into perspective, he was upfront with shareholders in his October 2008 letter regarding the difficulties of managing redemptions.