Mutual funds have usually met net redemptions first from cash on hand, and then by selling portfolio assets. Since receipts from brokers are generally due in three days, funds also borrow for this period to meet redemption obligations on time. Few borrow for longer periods, since regulators and fund boards and lenders dislike the risk that assets must be sold later at a lower price. Cash on hand is always the first choice, and is cost-effective in moderation. Its cost per dollar of redemptions covered is annual cost of holding cash divided by number of times spent in covering them per year. Since small accumulations of net redemptions occur more often than large ones, less cash kept means faster cash circulation and more cost efficiency. Large cash buffers also mean longer average periods before positive flow replenishes cash, and bring the same risk that assets must be sold at a lower price. For these good reasons, most funds keep buffers low and liquidate to replenish them.

Liquidation is always prudent at some point, as redemptions spike or accumulate, but is expensive. It brings brokerage costs, market impact, and tax effects to passive shareholders. Research on such costs by the Plexus Group, Abel/Noser, Elkins/McSherry, Roger Edelen and others can be accessed here. Costs vary by investment style, generally tracking the liquidity of portfolio assets. Small funds are not immune from market impact, since they tend to buy and sell in synchrony with larger funds practicing the same investment style. On days when small funds are selling internationals and buying small-caps, for example, the whole market is likely to be doing the same. Index funds and others with very slow tactical turnover, meaning portfolio trades to optimize performance rather than to meet redemptions, will also bring costly tax events in liquidations because of longer-accumulated gains.

ReFlow makes economic sense because it is cheaper to trade fund shares automatically at NAV, in formula amounts, than to bargain daily for multiple portfolio issues in securities markets. Since ReFlow is automatically contrarian, however, and exposed to market risk, it bears any costs of market autocorrelation ("momentum"). And since it eases portfolio turnover of clients by generating portfolio turnover of its own, as it buys and redeems fund shares, it is a “tax magnet” designed to draw tax events from their passive shareholders to itself. For such reasons, ReFlow could not survive without a fee. Its fee is the market-determined clearing price for its services, unless a minimum is imposed. So long as ReFlow’s capital is small compared to market demand for it, the clearing fee will probably be determined by funds with highest alternative costs. Fee levels should fall with time, if investment grows as hoped, and should stabilize at the rate which brings investors a competitive return.

ReFlow therefore fits between the cash and liquidation alternatives. After a small cash buffer, prudent use of ReFlow should prove several times more cost-effective than even the most economical round-trip trades of bonds or equities to meet redemptions. Although ReFlow probably costs less than most one-way trades as well, immediate liquidation remains best from the point where cumulative redemptions are unlikely to be reversed by growth within ReFlow’s holding period limit, since these unreversed outflows probably mean that portfolio assets will have to be sold anyhow.