Afterthoughts on market timing
More questions than answers
After penning a recent overview of the OSC’s investigation and settlements in
the mutual fund market timing scandal, I reflected further on the whole
situation. While many may be tired of hearing about this issue, there are
important loose ends left by the OSC’s recent investigation and string of
What about the others?
It is generally agreed among industry people and media outlets that many more
mutual fund companies allowed market timing other than the five named publicly
by the OSC. Settlements have been reached with four firms - AGF, AIC, CI Funds,
and Investors Group - while Franklin Templeton Investments was named as the
subject of an investigation after the other settlements were confirmed.
2004 Globe and Mail special report suggested that AIM, Clarington, Dynamic,
Elliott & Page, GGOF, HSBC, Mackenzie, R Funds, RBC, Scotia, MD Management, and
Talvest also had various degrees of market timing in some funds between 2000 and
2003. It’s important to highlight, however, that many of the funds listed in
that article had and still have small asset levels. A fund with $20 million in
assets is more likely to see a higher ‘churn rate’ than a fund that is $200
million or $2 billion in size. Hence, not all of the funds listed may have been
‘market timed’ but they may have missed others that had.
Obviously not all companies were pursued, which the OSC has all but
January 2005 article by James Langton in Investment Executive states, in
So, it seems not all the firms that consciously allowed market-timing
have been caught in the OSC enforcement action. Indeed, the OSC acknowledges
as much. “Our purpose is not to punish all wrongdoers but to protect the
market,” says Michael Watson, director of enforcement at the commission. “We
have sent a strong message to the industry with the settlements reached. In
fact, the market-timing practices have stopped since we began our probe, and
procedures are in place to detect and prevent them in the future.”
Perhaps the OSC has a point but investors in the fund companies that did
allow rapid trading but won’t be investigated don’t feel all that protected. And
if several fund companies involved in market timing were not pursued, it stands
to reason that many involved MFDA dealers and IDA brokers also escaped the
pursuits of their respective regulators.
Most puzzling is the fact that the OSC disregarded fund companies mentioned
in the brokerage firm settlements. For instance, TD Waterhouse was penalized for
facilitating rapid trading of its own TD Small Cap Equity fund and two of Frank
Russell’s Sovereign pooled funds (of which TDWH was one of just a few exclusive
distributors). Seemingly, the ‘facilitation’ involved reducing or waiving
short-term trading fees for a few large investors while continuing to go by the
book and charging all of its smaller retail clients making similar trades.
Similarly, the RBC Dominion Securities settlement also confirms that some of
the market timing trades it facilitated occurred in its related RBC fund family.
But the respective mutual fund arms of RBC and TD were left alone.
What about ‘money market’ funds?
Interestingly, a key component of market timing activities has seemingly been
ignored over the past couple of years - namely, money market funds. Recall that
the traders that were rapidly trading in and out of funds were doing so by
moving between a firm’s money market fund and some of its foreign stock funds.
It did this because switches between funds in the same ‘family’ - i.e. CI Money
Market and CI International - settle on the same day the trade is submitted.
While all of the attention seems to be focused on the losses such trading
caused for stock funds, the impact of rapid trading on money market funds seems
to have been forgotten. While resulting losses in money market funds probably
pale in comparison to those suffered by foreign stock fund investors, the issue
should not be cast aside.
Losses in money market funds would have resulted to the extent that the in
and out trading forced the sale of treasury bills and other short term paper
prior to maturity. As with all fixed income securities, there is an implicit
cost known as the ‘bid-ask’ spread - i.e. the difference between the purchase
and selling prices of money market instruments. Given the level of trading noted
in the various settlement agreements, I estimate that a money market fund could
have seen 500 round trips in a year from an institutional trader. Each trade was
typically $1 million and up.
For retail investors, a round trip (i.e. buy and sell before maturity) on a
90-day Government of Canada treasury bill is something like 0.5% at a discount
broker. Assuming that institutional pricing costs only 1/10th of that, it can
get very costly for a money market fund manager to sell money market securities
prior to maturity if rapid trading required heavy turnover at the fund level.
Interestingly, turnover figures are not published for money market funds but
the information is available in the fund financial statements to calculate money
market turnover rates.
While the OSC looks to have all but wrapped up its investigation with record
fines in the spirit of protecting markets, there are many investors who are left
with disappointment and fewer dollars in their mutual fund accounts. This is
just the sort of situation that may spur otherwise ‘too polite’ Canadians to get
into a litigious mood.
Dan Hallett, CFA, CFP is the President of
Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as
Investment Counsel in Ontario and provides independent investment research to
financial advisors. He can be reached at