Effect of mutual fund sellers on remaining holders

[joesxm]

I saw an article today that made me think about this.

It said that most mutual funds are not holding a lot of cash at the moment and although they would like to be buying stocks at these low prices they can't because of the way the cash is flowing out of the funds.

It said that unlike an individual stock where you must find a buyer in order to sell your stock, the mutual fund must redeem a share at the current NAV for anyone who wants to redeem shares. This results in the fund having to sell shares at the inopportune time to get cash to pay the redeemers.

It seems to me as if the redeemer is actually getting a benefit at the expense of the remaining mutual fund holders.

Here is my scenerio - does it make sense?

Assume that the mutual fund has 1000 shares of a stock worth $10 per share and mutual fund holders have 100 shares of the fund. The NAV is $100.

Holder A redeems 10 shares and the fund has to pay Holder A $1000. This amount is set at close of business on Monday.

If the fund does not have enough cash it needs to get some before the settlement date. That would mean it needs to sell some of its stock on Tuesday.

Assume that the price of the stock on Tuesday is $9 or that the act of the fund selling the shares drives the price down.

To get the money for Holder A the fund has to sell roughly 110 shares of the stock. That leaves the fund with 890 shares of stock.

It would seem that Holder A who redeemed, causing problems for the fund got compensated with the value of 100 shares of stock, but because the fund had to raise cash at the wrong time, the remaining Holders now have only 890 shares of stock instead of the 900 shares that they should have.

Because of this, when the price of the stock recovers the mutual fund holders will be worse off than if they had held the stock directly and had not sold any of it.

This seems to amplify the pain in a down market with panic.

I suppose if the market were going up, then the fund holders would gain from people selling since it would be the opposite of my scenario. I would think that this would happen less often.