Market Timing Revisited
The mutual fund scandals may be more about growth and survival.


The sparks continue to fly around the mutual fund scandals, and Invesco is the latest fund firm to be accused of criminal misdeeds.

Stephen Cutler, the SEC’s head of enforcement, told the New York Post that “Invesco Funds Group and its CEO willingly sacrificed the interests of mutual fund shareholders,” while the spotlight-craving Eliot Spitzer darkly warned that those who tolerated market timing “will face fraud charges.”

With the charges against Invesco the headline story in last Wednesday’s Wall Street Journal, it is perhaps worthwhile to look back at the report on Invesco filed by the Journal’s Susan Pulliam and Tom Lauricella in last Tuesday’s edition. Their findings, though phrased negatively, seem to confirm the assumption that while fund firms took on market timers as a way to grow and pay the bills, performance was always the top priority of both the fund managers and fund executives.

What the article did not speak of was excessive SEC violations like late trading, nor did it detail violations in the often-murky area of late processing. Though market timing clearly occurred, the article made it apparent that this dubious practice wasn’t just frowned on by performance-obsessed portfolio managers, but also by top Invesco executives. Invesco’s story is clearly one about the desire to grow, and to some degree, to survive as the markets cratered in the early part of this decade.

Pulliam and Lauricella reported that though just a small player with $1.8 billion under management in 1990, Invesco’s managers made a concerted effort to grow their fee-generating asset base in the 1990s. According to Pulliam and Lauricella, “the push for growth ushered in the market timers.” Eliot Spitzer confirmed this in last Wednesday’s New York Post, saying the market timing “was condoned because it was a lucrative source of management fee revenue.” Jerry Paul, a former Invesco fund manager, was quoted as saying that $200 million of his $1 billion high-yield fund came from timers.

Paul went on to say that market timers were a “pain,” and forced him to keep a greater portion of his assets in cash. Mark Greenberg, fearful of what market timers would do to his Invesco Leisure Fund, kicked them out altogether. Invesco fund manager Brian Hayward was actually able to quantify what he felt market timers were losing him in terms of returns.

Obviously market timers were not kicked out of Invesco completely, but these examples more than suggest that managers were aware of how active trading could harm long-term returns and shareholders, and ever watchful of their track records, portfolio managers at Invesco made a concerted effort to keep “hot money” in their funds at a minimum.

Notably, upper management at Invesco was similarly aware of the importance of returns taking precedence over the income that could be earned from the market-timing hedge funds. Pulliam and Lauricella point out that management only allowed certain funds to be traded in, and even imposed exit fees of 2 percent on some of its funds to ensure that timers would not wreak havoc.

This speaks to the assumption that fund companies aggressively tipped the balance of interests in favor of their long-term shareholders, and away from the timers. Invesco executive Doug Kidd said as much in a statement on December 1, in which he spoke of market timers being limited in terms of dollar amounts, frequency of trades, and restrictions on funds in which trades could be made.

Still, the Wall Street Journal alluded to a widespread belief among fund managers that the bosses at Invesco “were willing to accommodate the timers in order to stem the flow of money away from their funds during a down market.” This is interesting, because while all seem to agree that the courting of market timers was a growth strategy, can it also be assumed that market timers helped keep fund companies like Invesco afloat during the recent market bust?

No one would argue that mutual fund firms were experiencing a higher rate of redemptions during the not-too-long-ago bear market, and with funds and fees falling back then, is it much of a stretch to say that market-timing dollars seemed rather attractive? It appears that Invesco executives saw it this way, judging by a report in last Wednesday’s Journal noting that market-timing dollars hit a high of $900 million at Invesco in mid-2002.

That market-timing assets grew during the bear market should draw scrutiny for reasons beyond fund-company cash flow. Indeed, it’s also conventional wisdom that the presence of market timers caused fund managers to keep extra cash on the sidelines to fund redemptions. Invesco’s Brian Hayward lamented as much in last Tuesday’s Wall Street Journal.

Since everyone agrees on this, can it then be said that during the bear-market years, market timers not only helped pay the mutual fund companies’ bills, but that they inadvertently aided small investors in funds for the simple reason that managers were required to keep more of their money out of a falling stock market?

Here’s hoping that the regulators and elected officials eager to make a career off of these scandals start asking these kinds of questions. The more one reads between the lines, the more it seems that the mutual fund scandals have very little to do with the Invescos opening themselves up to late trading and other regulatory violations, and more to do with growth and survival, and the allowance of dubious but legal market-timed trades to fund both. At least, happily, Invesco plans to contest these charges vigorously; all evidence so far suggests that it should.

— John Tamny resides in Washington, D.C., and spent four years in the brokerage business. He can be contacted at [email protected].