Finance: Mutual Funds
Mutual Funds: Fast-Buck Traders Get the Heave-Ho
Funds Turn up the heat on so-called market timers
Market timers vs. mutual-fund managers: The battle between the two sides may be somewhat arcane, but the stakes could be high for fund investors.
Professional timers, many of whom control millions of clients' dollars, dart in and out of funds, taking advantage of the cost-free entrance and exit features of no-load mutual funds. Depending on their trading system, the timers might keep their money in a fund for months, weeks, or--in an increasing number of cases--just a few days.
Fund managers complain that all that sloshing around can raise a fund's overhead and lower returns. Timers' moves can possibly raise the tax bill for the buy-and-hold investors if the funds are forced to sell stocks with capital gains to meet redemptions. In the past, most funds dealt with frequent switchers with warnings to stop or leave.
Now, fund managers are getting serious. They're slapping on redemption fees, with the hope that the timers will curb the short-term trading. On Aug. 16, Oakmark posted 2% redemption fees for shares sold in less than 90 days. The charge applies to all but the Oakmark Fund And the Oakmark Equity & Income Fund.WARNING. The fees were not Oakmark's first choice. William C. Nygren, portfolio manager of Oakmark Select Fund says the company has been policing suspected timers for a while, sending warning letters to accounts that made short-term trades of $1 million or more. The million-dollar trades eased up, says Nygren, but then there was a a jump in the number of short-term trades in the high six figures.
Nygren says the firm's international funds were particularly frequented by timers who bought international funds when Wall Street rallied, betting on a follow-through rally the next day. Indeed, Invesco Funds recently slapped a 1% exit fee on four international and one high-yield bond fund that applies to redemptions made within 90 days.
Some companies are trying to timer-proof their funds before the hot money finds them. Firsthand Funds has two new technology funds in registration that will have 2% redemption fees on shares held less than six months. Earlier this year, Firsthand Technology Innovators Fund, then $60 million in assets, was hit with a $10 million redemption--"and we had to sell positions we otherwise would not have," says Steven C. Witt, a Firsthand managing director. Witt says Firsthand hopes to extend those fees to all its funds and predicts most fund groups will adopt them.
To the timers, these latest bars on the exit doors are too much. "The funds want to accept timer money but then be able to lock the door when the money wants to leave," says David Lucca, a timer with Rhoads Grunden Lucca Capital Management in Lancaster, Pa., and president of the Society of Asset Allocators & Fund Timers Inc. (SAAFTI). "They can't have it both ways."
Lucca suggests that the fund companies are going through a tough time, and they're trying to make "timers into scapegoats." Timers are easy targets: Academics argue that timing doesn't work, and most timers have underperformed the bull market.
So have the funds. Nearly 96% of the diversified U.S. equity funds underperformed the Standard & Poor's 500-stock index over the past five years. That's why some investors are choosing low-cost index funds instead of the high-fee, actively managed portfolios. Or they opt out of funds entirely, going to separately managed accounts or cheap, do-it-yourself online investing. As a result, cash inflows are declining. Inflows to equity funds peaked at $227 billion in 1997; so far this year, the annualized rate is about $180 billion.
That could explain why fund companies are getting edgy about the timers. Without a stream of new money, big redemption orders could force them to liquidate shares often at inopportune times, such as selling into a falling market. But timers say an outflow of assets could be more detrimental to the fund companies, which are worried about their own revenues. "They're raising fees to hold on to assets," says Douglas Fabian of Fabian Premium Investment Resource, a switch-fund newsletter. "And they are doing it under the guise of helping investors." James O. Rohrbach, president of Investment Models Inc. argues that exit fees can work against investors' interests: "A 2% fee may stop some people who would be better off selling the fund."
Fund companies insist they are looking out for long-term shareholders. And in most cases, redemption fees go back into the funds to help offset higher commissions and market-impact costs resulting from increased trading. Two notable exceptions are charges levied by the no-transaction-fee fund programs at Charles Schwab & Co. and Fidelity Brokerage Services, which keep their redemption fees to offset their costs. "We needed to create some speed bumps," says Jeffrey M. Lyons, Schwab's senior vice-president for mutual-fund marketing. "We were looking out for the interest of the funds, but we also wanted to curb excessive trading because that's a cost to us."UNFRIENDLY. Earlier this year, Schwab lengthened the amount of time investors had to hold a fund in the OneSource program before the sale would trigger a redemption fee; retail accounts must now hold 180 days, and institutional accounts, 90 days. And Fidelity went from five free switches per year with no minimum holding period to levying fees for those who sell within 180 days.
While funds and timers often have had conflicting interests, they usually have found ways to work them out. SAAFTI's Lucca says the association's Fair Practices Policy tries to minimize timers' impact on the funds. The practices include clearing timer investments with the fund beforehand, limiting to 5% the amount of a fund's assets that one timer controls and, if possible, giving funds advance notice of withdrawals.
But that isn't enough for some fund groups. "More and more funds are becoming timer-unfriendly," complains Bruce Freimuth, president of Financial Timing Services Inc. in St. Louis. Last winter, he says, Legg Mason Funds asked him to take his $7.5 million, split between the Legg Mason Value Trust and Legg Mason Special Investment Trust, and go elsewhere. At the time, Value Trust was more than $8 billion and Special Investment more than $1 billion. "They were huge funds," he says. "How was I going to adversely affect them?"
Load funds attract fewer timers than no-loads, but load-fund managements are no more tolerant of them. AIM Funds, a $115 billion group, last year booted timers with a collective $600 million. And starting Sept. 15, AIM shareholders will be limited to 10 switches per calendar year--and management says frequent traders may be cut off sooner. Timer Bob Pritchard, who works out of Wedbush Morgan Securities Inc. in Eugene, Ore., says he was surprised in June when MFS Emerging Growth Fund refused to take what would have been his 13th trade of the year. He persuaded them to take his sell orders but has not done any further trading with MFS Fund. Pritchard, who switches on average once a week, also stopped using Van Kampen Enterprise Fund because it plans to limit shareholders to eight exchanges per year.
It's not as if timers have nowhere to go. In fact, several mutual-fund groups--Rydex, ProFunds, and Potomac--explicitly court timers. Freimuth puts new clients in timer-friendly funds, but he still has more than $70 million of his $119 million in two no-load fund families, which he declines to identify. "They're grandfathered in," Freimuth says. But he's concerned that if current trends hold up, those fund groups, too, might show him the door.By Jeffrey M. Laderman in New YorkReturn to top