Market-timers finding their business isn't wanted

Your Funds

Dollars & Sense

September 10, 2000|By CHARLES JAFFEE

Most shareholders are not aware that their fund company may be allowed to refuse trades, limit account activity, cut off basic services or ask them to take their money elsewhere.

Many fund families have had this power for years, and more are seeking to add it.

If you were unaware of such trading sanctions, it is most likely because you are not a market-timer, moving money in and out of funds regularly.

But with many big names (Vanguard, Fidelity, T. Rowe Price, American Century, among others) already discouraging timing and another industry leader, Franklin Templeton, adding new rules, your fund's trading policies probably deserve some attention.

The Franklin Templeton program - which formally becomes active Nov. 1, but which is effectively in place now - identifies market-timers and stops taking new money from them.

It also limits timers with current accounts to transactions only in funds in which they already have money (making it impossible to move completely from one hot sector to the next) and makes them register with a "market-timing desk," which will review trading activity before it is allowed to go through.

Essentially, the review process will hold up a trade until the company is sure the activity is not so big or frequent that it causes problems for long-term shareholders in the funds.

Market-timing, as practiced mostly by professional investors and financial advisers in funds, tends to be a quick-turnaround/here-today-gone-tomorrow form of investing. The investor is buying the hot sector or market, hoping to catch an upswing and planning to bail out before a downturn.

It can cause problems for funds because timers can present huge swings in cash flow. The money flows in, the fund manager invests it, and then the money flees and the manager may be left looking at selling stocks in order to meet redemptions.

Long-term shareholders pay the cost of those trades; short-term timers don't mind dragging the fund down as they get out.

To avoid hurting the long-term shareholders, many fund companies have long had policies to discourage trading. Some institute short-term redemption fees, by which anyone who sells the fund within a short time of purchase - anywhere from 90 days to two years, depending on the fund - pays a fee to get out.

The fee goes back to the fund (not to the management company) to cover the trading costs. But the Securities and Exchange Commission effectively capped short-term redemption fees at 2 percent when it refused to let Fidelity implement a higher charge early this year.

Since redemption fees haven't completely discouraged timing, fund groups including Franklin Templeton are making new rules.

"We think it is for the good of all of our shareholders if market-timers go elsewhere," says Peter Jones, president of Franklin Templeton Distributors. "We're just not allowing new market-timing money into the funds. If it's in there, or if it somehow gets in there, we'll be encouraging it to leave."

Many fund companies have had similar policies for years. Vanguard, for example, cuts off telephone and wire switching privileges - essential for anyone wanting fast moves as part of a timing strategy - for anyone who exceeds two round-trips per year. (Vanguard doesn't allow phone and wire trading of its index funds.)

Certain Fidelity funds are subject to a transaction limit, while T. Rowe Price, American Century and seemingly every fund company using a "momentum strategy" that could appeal to market-timers also have a protocol for stopping the problem.

Usually, it starts with a letter. Then, maybe, a phone call. Finally, if heavy trading continues, the account is frozen until the investor leaves. (Sometimes an entire financial planning or brokerage firm with a history of timing is barred, blocking all of the firm's clients - even buy-and-holders - from the funds.)

Most funds with trading limits stick the rules in the back of the prospectus, under some sort of caveat about "account activity limits" or abuse of trading privileges.

"Having policies to handle market-timers keeps timing from becoming a problem, which is why more firms are doing this," says Peter Kris of the momentum-driven Van Wagoner funds, which discourage timing by shareholders. "If we determine that someone is timing the fund, we'll speak to them. If they don't stop, then we will stop them."

Charles A. Jaffe is mutual funds columnist at the Boston Globe. He can be reached by e-mail at jaffe@globe.com or at the Boston Globe, Box 2378, Boston, Mass. 02107-2378.

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