“IF GOD had not meant for them to be sheared, he would not have made them sheep”, Robert Hiscox, a former deputy chairman of Lloyd’s of London, once said of the insurance market’s “Names”. He’s acard, that Mr Hiscox, and the remark at least had the merit of being quite genuinely funny. Yet his candour in suggesting that investors are only sheep to be fleeced was also a shocking admission ofan always half suspected truth. The US mutual funds industry seems to have adopted very much the same attitude in agreeing to allow hedge funds to take advantage of market timing opportunities tomake a fast buck at the expense of ordinary investors.
Of all the abuses discovered on Wall Street this past three years, this is undoubtedly the worst, because it is so plainly dishonest and so obviously disadvantages funds meant for the little guy in favour of money grabbing financial professionals. Eliot Spitzer’s crusade against Wall Street has sometimes been of questionable validity and motivation. But by alighting on an abuse that everyone can understand and directly affects millions of small investors, the New York Attorney General has hit the spot with his market timing revelations. Belatedly, Britain’s Financial Services Authority has clambering aboard the bandwagon.
To date, the British fund management industry has been able to characterise market timing abuse as almost entirely an American problem. Yet it actually seems highly likely that it happened here too, albeit on a quite limited scale. The reason for believing this is firstly that at least two of the fund managers at the centre of the scandal in the US also have considerable fund management operations in Britain. The other reason is that almost every fund manager you meet admits to having been approached by the hedge fund industry to participate in the market timing scam, but somehow or other managed to resist its siren calls.
The British fund management industry is also more open to this kind of abuse than the American one, if only because most prospectuses in the US specifically ban short term traders from the funds, whereas in Britain there is no such rule in most cases. It beggars belief no one at all in the British fund management industry would have agreed to what the hedge funds were suggesting. Callum McCarthy, the newish chairman of the Financial Services Authority, therefore determined to grip the issue by summoning the industry to account for itself. Each fund manager must either declare itself blameless or admit to its misdemeanours by Christmas eve. It would be amazing if there were not at least one rotten apple in the barrel.
Market timing abuse works like this. In return for placing large amounts of business with the fund manager, the hedge fund is allowed to trade in and out as much as it likes. Mutual or unit trust prices are set only once a day, so that if the portfolio of shares in the managed fund rises in value, the hedge fund has the opportunity to buy at a price it knows will be bettered the next day, when the units will be sold and the profit pocketed. The losers are the fund’s long term holders.
We can only hope that the problem is not as widespread here as it has been in the US. After the long bear market, the fund management industry already has a herculean task ahead of it in rebuilding public trust. The last thing it needs is another scandal. Yet that may be what it is about to get.
