Waddell & Reed Shows Long-Term Investor Can Unhinge Wall Street

Waddell & Reed Financial Inc., the mutual-fund manager based in the heart of Kansas that caters to mom and pop investors, is an unlikely company to be blamed for sending Wall Street into a tailspin on May 6.

“They’re a long-term, buy-and-hold investor,” Geoff Bobroff, a fund-industry consultant in East Greenwich, Rhode Island, said in a telephone interview. “Their nature is not of an organization that is an active trader.”

The automatic execution of a sale order on a large block of futures with no regard for price helped trigger the May 6 stock market crash, which snowballed into an $862 billion rout, regulators said in a report released today. Waddell & Reed, which manages about $68 billion, was the seller, said two people with direct knowledge of the report, which doesn’t name the firm.

“One key lesson is that under stressed market conditions, the automated execution of a large sell order can trigger extreme price movements, especially if the automated execution algorithm does not take prices into account,” according to the report from the U.S. Securities and Exchange Commission and Commodity Futures Trading Commission.

Hedging Strategy

The company, started 73 years ago by Cameron Reed and Chauncey Waddell, was unloading Standard & Poor’s 500 Index futures, known as E-minis, in the course of normal hedging of its holdings, according to the report. The trading may not have prompted a retreat had investors not already been rattled by negative news, including a worsening of the European debt crisis, said the people.

Waddell said it sold 75,000 E-mini contracts, or 1 percent of overall trading volume in the derivative on May 6, according to a statement from the company.

“We believe we were one of 250 firms engaging in E-mini trading during the period of the market selloff,” the company said in the question-and-answer-style statement first released in May. “We believe that trades of the size we initiated normally are absorbed easily in the market.”

Roger Hoadley, a spokesman for the Overland Park-based company, said the statement was “still accurate and relevant.”

SEC Chairman Mary Schapiro asked the agency last month to examine whether the loss of traditional market makers has hurt investors. With market making now dominated by hundreds of automated traders with few rules for when they must buy and sell, the SEC will consider ways to keep the biggest from abandoning the market at the first sign of trouble.

High-Frequency Firms

After the May crash, U.S. lawmakers including Senator Ted Kaufman, a Democrat from Delaware, asked if the high-frequency firms that have supplanted specialists and market makers with strategies that transact thousands of shares a second destabilized trading by stepping away when they were needed most.

Waddell & Reed, started with less than $125,000 in assets during the Great Depression, is the opposite of a high-speed trader. Like most mutual-fund firms, it holds onto its investments for months or years. Like other firms, it trades futures to minimize losses from unexpected market fluctuations.

The firm is small compared with the largest fund managers. Vanguard Group Inc., based in Valley Forge, Pennsylvania, is the biggest U.S. mutual-fund manager by assets, with $1.31 trillion. Fourteen individual U.S. mutual funds hold more assets than Waddell & Reed, according to Bloomberg data.

Waddell & Reed, which went public in 1998, fell 10 percent this year through yesterday, compared with the 4.1 percent decline by the Standard & Poor’s index of asset managers and custody banks. Its market value is $2.3 billion, compared with $32.6 billion for New York-based BlackRock Inc., the biggest publicly traded money manager.

Not Ideal PR

Jeffrey Hopson, an analyst at Stifel Nicolaus & Co. in St. Louis, said the report is unlikely to damage the company in the long term.

“It’s not ideal PR, but the activity didn’t represent anything unusual,” Hopson said in a telephone interview.

Bobroff, the consultant, said Waddell’s distribution structure will help protect it from any reputational fallout with individual investors. The company sells to individual investors almost exclusively through intermediaries, including its own network of financial advisers, who have a direct relationship with their clients.

Waddell & Reed is run by Henry J. Herrmann, a 39-year veteran of the company who became chief executive officer in 2005 and added the post of chairman in January. Herrmann, 67, joined the firm as an analyst and served as a fund manager and chief investment officer.

Fund Returns

The $21.4 billion Ivy Asset Strategy Fund, the company’s largest, has returned 2.2 percent this year, worse than 89 percent of rival funds, according to data compiled by Bloomberg. The fund, which can invest in stocks, bonds and short-term securities, has outperformed 99 percent of competitors over the past five years, returning an annual average of 10 percent.

In the past five years, the Waddell & Reed owned funds, including the Ivy fund series, that invest in both stocks and bonds beat 86 percent of U.S. fund companies in that category, according to Chicago-based research firm Morningstar Inc. Waddell’s taxable bond funds topped 41 percent of competing fund families. Its domestic and international stock funds ranked ahead of 63 percent and 49 percent of rival companies.

Waddell was one of several mutual-fund companies that settled claims by the SEC earlier this decade. The company paid $77 million in 2006 to resolve accusations that it allowed certain clients to make improper trades.

To contact the reporter on this story: Christopher Condon in Boston at ccondon4@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net

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