As the mutual fund industry scrambles to cope with investigations into improper trading of fund shares, some small fund companies are poised to gain business. Last week, Eliot Spitzer, the New YorkState attorney general, said his office had uncovered widespread illegal trading between hedge funds and mutual fund companies. Of particular concern was the timing and frequency of trades. The smallfund companies say they welcome frequent traders, known as market timers.
The Spitzer action may be having a chilling effect on the conventional mutual fund business, said Michael Sapir, chairman of ProFunds, which manages $4.5 billion in assets. But our portfolios are set up to accommodate huge pools of assets moving in or out of our funds.
Sapir said ProFunds had gained $200 million in assets since the investigation by Spitzer became public. ProFunds, along with two other firms, Rydex Funds and Potomac Funds, which manage $8.1 billion and $500 million, respectively, do not limit the number of times investors can trade in and out of their funds. Many of the larger fund companies have restrictions on such trades. At Vanguard, for example, investors in the firm’s popular index funds are allowed to trade in and out of the funds just twice in 12 months. Restrictions put in place by Vanguard and others have made it harder for mutual fund market timers to invest in their funds. In the old days, you went to a mutual fund company and said, ‘I’m a short-term trader,’ and they would often say ‘O.K.,’ or they might restrict you to a certain amount, said Albert Hallac, chairman of Weston Capital, which manages $1.1 billion allocated among different types of hedge funds. Hallac, who used to trade in fund shares in the 1970s, now manages a small portfolio devoted to managers of hedge funds that trade in mutual fund shares. Over time, he said, mutual funds became increasingly reluctant to permit such trades. Still, he said, some do allow it probably $20 billion or more is devoted to such trading. Firms like Rydex that permit market timing draw a distinction between the sorts of investing they encourage and the kind of trading done by Canary Capital Partners, a hedge fund that settled with Spitzer’s office for $40 million last week. They do not allow trading in their funds’ shares after the main U.S. stock markets close, for example. All three firms also mostly manage index funds, so that it is easy to reinvest cash that comes in. Funds that depend on managers’ ability to choose stocks are more hampered by rapid flows of money in or out. Spitzer has said that market timers who buy and sell shares of a fund in a day or less hurt small, long-term investors because it costs the fund money to manage such erratic flows of funds.
