NEW YORK (HedgeWorld.com)-- Non-traditional, indirect ways to arbitrage markets are emerging while as much as US$1 billion or more in market timing assets may be moving into index funds that do not restrict the frequency of trading in their shares.
Since New York Attorney General Eliot Spitzer announced at the beginning of September a wide-ranging investigation into the trading of mutual fund shares, market timing has been lumped together with trading at the day's price after market close. The latter apparently violates Securities and Exchange Commission rules, but there is no law against market timing.
Mr. Spitzer and the SEC claim, however, that there are market-timing abuses. Many mutual funds that discourage quick trades in their public offering documents allowed certain hedge funds and other traders to engage in the practice in exchange for various favors they provided to the mutual fund companies. Long-term shareholders unknowingly shouldered the costs imposed on funds by such trades.
But some index funds have no upper limits on the frequency of exchanges. Because they do not actively manage assets but track an index, it is easier for them to invest new money and liquidate to accommodate outflows. Some, such as Bethesda, Md.-based ProFunds, do not charge transaction fees.
Less-known alternatives for market timing are closer to the hedge fund world. These include Invesdex Ltd. in Bermuda, which offers an over-the-counter futures derivative contract that can be linked to the performance of any combination of indexes or assets, such as the S&P 500, Nasdaq 100, FTSE 100, Hang Seng and industrial sectors .
This instrument is somewhere between futures, index mutual funds and exchange-traded funds, according to Valere Costello, president and chief executive of Invesdex. Besides equities, it also can be used for bonds and commodities such as gold and crude oil. Investors can select direct or inverse exposure.
"We're like mini funds tailored to individual account holders," said Mr. Costello. The instrument can be traded inter-day. Unlike index mutual funds, it is not for retail investors--customers are hedge funds, advisers managing offshore money and managed account businesses.
In the meantime, inflows to some index funds that allow short-term trading are at phenomenal levels, although it is not clear how much of that is due to market-timing activity. For example, Rydex Funds received US$2.7 billion year to date and is one of the fastest growing mutual fund companies in the United States.
In the last quarter alone Rydex gained US$1 billion. Total assets now are at US$9.1 billion. This growth dates back to late last year and has been fairly steady, said a spokeswoman.
An inverse bond fund that is a good place to invest if you expect interest rates to go up is among the Rydex funds that are particularly popular right now. Inflows also are large at an over-the-counter fund indexed to the Nasdaq 100 and a large-cap Japan fund that provides leveraged exposure to the Japanese market.
By contrast, some mutual fund groups named in Spitzer's inquiry have experienced heavy withdrawals. For instance, US$4.4 billion left Janus funds in September. Their public stance against short-term trading, a commitment in prospectuses they filed with the SEC, worked against these companies once their willingness to allow exceptions for favored clients came to light.
Both the SEC and the New York attorney general say they will continue to crack down on market timing and late trading abuses. Regulators are considering whether to require mutual funds to always reflect the fair value of their shares so that nobody can take advantage of stale prices.
Exchange-traded funds, priced through the day, have no such problem and are available for market timing, but by the same token they provide limited opportunity.