What is market timing?
Market timing is a form of arbitrage based on the fact that funds can be invested in equities listed on stock markets with different time zones.
Unit trusts are priced at 12 noon, and any investor buying or selling before then will get that price. If the fund contains US equities, they will be valued at their closing price from the day before, because American stock markets are not yet open. If a major event has taken place which is likely to affect the value of that stock, it is not reflected in how it has been valued by the unit trust.
Sophisticated investors can take advantage of the fact that they know when the US stock market opens, the price will soar, by buying into the unit trust. Having made a large profit, they then sell out quickly. The same applies to funds invested in Asian funds.
Why is the Financial Services Industry investigating?
Market timing is becoming increasingly controversial but it is not illegal. However, the process, used mainly by large investors such as hedge funds, can harm long-term investors, usually private individuals.
US regulators have already waged a high-profile campaign against fund managers who have used market timing.
The FSA says it will not ban market timing but instead wants to strengthen regulations so that private investors are not disadvantaged.
In practice, tighter regulations could stamp out market timing by making it more costly and time-consuming.
Why does market timing harm investors?
Fund managers have to convert cash handed over by an investor into shares within its portfolio. That involves a trading cost. Market timing is an abuse when fund managers do not pass on the dealing costs to the market timers, which usually invest large sums and want to enter and then exit a fund rapidly.
Who is most at risk?
As market timing takes advantage of time zones, those invested in overseas funds such as US or Asian equities are at risk. Those in funds based at offshore centres are also likely to be more exposed to market timing because regulations there are less stringent.
What is late trading?
Unlike market timing, late trading is illegal.
If anyone is found to have committed it in the UK, they would be likely to not only be fined but also be barred from working in the financial sector and probably prosecuted.
