However, the company now says it will impose trading restrictions in all its funds, and will continue to investigate market timing, including the 11 funds not examined before. It also reported that its prospectuses have been adjusted to say that it prohibits excessive trading activity.
Generally, market timing, the quick buying and selling of funds, takes place in those funds containing international stocks or securities because there is a time lapsethat allows investors to profit from stale prices. The practice is not illegal, but many funds have policies barring it because it reduces a fund’s performance. However, unnamed investors in MFS Investments’ funds were market-timing broader based funds, and used complex hedging strategies to do so, according to specialists and attorneys involved in the growing mutual fund investigation.
The 11 funds under investigation were either large-cap domestic stock or high-grade bond funds containing actively traded, highly liquid holdings that weren’t susceptible to stale prices, according to a story in the Boston Globe.
MFS is now arguing that because they were domestic funds the frequent trading was not detrimental to the funds’ performance or its investment policy. However, according to financial specialists and attorneys involved in the cases, there are still ways market timers could profit from frequent trading in these funds, especially when moving hundred of millions of dollars over a few years, reported the Globe. The different strategies suggested include multiple hedging strategies, such as those employed by Canary Capital when trading in and out of INVESCO funds (see Prosecutors: Invesco Engaged in Massive Market Timing Scheme ).
Hedging strategies include buying derivatives, or financial instruments investors employ based on the holdings of the mutual funds they are timing, such as futures contracts or contracts on a basket of stocks correlating to the funds’ holdings. Market timers then make decisions based on how they expect the mutual fund to trade.
In addition to various hedging schemes, market timers can also profit from what is called a momentum play, used when investors are counting on a rebounding market. In a momentum play, investors buy into a fund assuming that broader market conditions are going to rise, and that the fund’s price will also rise, and then, when it does, the investor quickly sells the fund.
MFS’s market timing practices are under investigation by New York and Massachusetts regulators and the company said earlier this week that it expected charges from federal regulators (see MFS Expects To Be Charged in Fund Probe ).