Trading Places…Have Mutual fund practices put your retirement at risk?
You cannot pick up a newspaper these days that doesn't have a headline about one mutual fund trading scandal or another. As a participant in a retirement plan with investments in some of these same mutual funds, you may well wonder what that means to you. To date, two types of trading violations have been alleged:
• Late trading: This involves buying mutual fund shares at the current price after the market has closed (4 p.m. ET)it's like buying a lottery ticket when you know what the winning number will be, or betting on the outcome of a sports event when you already know the final score. Late trading is illegal.
• Market timing: This is a little more complicated-it is not technically illegal (yet)-and, from the volume of reports, it seems to be more widespread than some may have thought. At some level, it is "just" a carefully timed attempt to buy low and sell high. However, it is a practice that can cost other fund investors, and it is a practice that many fund companies claimed to prohibit or discourage-yet did not.
What is market timing?
Let's say you hear a weather forecast calling for an unexpected snowstorm. You run by the local hardware outlet, and notice not only that they have only two snow shovels in stock but also that those are on sale. So, you buy them both and head home. Thus, your neighbor, who hears about the snowstorm an hour later, is unable to buy a snow shovel when he gets to the store but you are happy to sell him the "extra" one-at full price. In that situation, you have profited from information about the "market" that was more timely than your neighbor's-and, while he didn't get the benefit of the sale price, he wasn't exactly robbed, either.
Market timing also involves buyers with more timely information-generally because they are watching market movements on an ongoing basis. The US stock market closes at 4 p.m. ET, but the markets in other countries close at different times. However, American-based mutual funds that invest in international stocks still generally determine the closing price for those mutual funds at 4 p.m. ET, even though it includes stocks in foreign markets that are still trading. An investor who is aware of those movements-and knows about the timing delay in the valuation of certain mutual funds-essentially can sell his holdings at an artificial profit.
How does that affect my account?
Like the neighbor, you wouldn't necessarily know that you paid more than you could have. Market timers essentially take advantage of their knowledge of the market, or of how the mutual fund is valued, to make a profit-and that profit comes out of your pocket. Additionally, that kind of rapid "in and out" trading makes it harder for the fund managers to do their job keeping monies invested because they have to have cash available for such sales-and the more trades, the more expensive it is to run the fund.
If it's not illegal, why the fuss?
Some mutual fund companies say in the fund prospectus that they don't allow such activities, or that they impose special redemption fees to discourage them-and those same firms allegedly allowed and encouraged such activities for a few, select, large investors. Basically, some fund companies cut a special deal with big investors-and other investors paid the price.
How much money are we talking about?
Nobody knows for sure at present. Much depends on which fund, and how long you were invested in that fund. However, the dollar impact on your individual account is likely to be fairly small.
Will this change my retirement savings account?
Perhaps. Your employer may already have communicated a change in some of the funds available in your program-or at least an acknowledgement that it is monitoring the situation. The SEC has proposed new rules designed to prevent late trading and market timing. In their current form, that could mean changes in when your retirement trades take place-and it could mean that you will have to pay redemption fees on short-term trading in your account.
What should I do?
Don't panic. Even if you currently have an investment in one (or more) of the mutual funds in the headlines, your retirement account may not be affected, or may not be affected significantly. Your employer will keep you posted on its review of the situation. Ultimately, if you're nervous, this may be a good time to rethink your overall asset allocation.
