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June 28, 2004 at 08:00 PM
NEW YORK (HedgeWorld.com)–Fair-value pricing is the best way to eliminate the mutual fund arbitrage opportunities exploited by short-term traders, said Leon Metzger last month in a letter to the Securities and Exchange Commission. Forward pricing is the next best option, he wrote.
The detrimental effect of such trades on long-run mutual fund investors is the rationale for an ongoing set of investigations of fund companies and brokerages by the SEC and some state attorney generals. New York’s Eliot Spitzer led the way last September, when he announced a settlement with the manager of liquidated hedge fund Canary Capital Partners.
Since then the SEC has proposed a new rule to impose a 2% redemption fee on mutual fund shares purchased within the previous five days, to force fast-moving traders to make up for the costs they impose on a fund. “If adopted, the proposal would allow funds to recoup some, if not all, of these costs,” according to the SEC.
Mr. Metzger, an executive of hedge fund firm Paloma Partners LLC in Greenwich, Conn., and leading author of a new paper on valuation from the International Association of Financial Engineers, considers the pros and cons of this proposal in his comment to the Commission.
He applies the same analysis to several other approaches that might be used to protect mutual fund investors. These include a five-day ban on redemptions, pricing of all securities at the next market closing price or next opening price and mandatory fair-value pricing.
Banning redemptions within five days has the drawback of potentially reducing liquidity. The 2% fee approach can be circumvented by market timers by using futures contracts. Forward pricing has other complications.
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