MONEY: Wilshire Conducted Rapid-Fire Mutual Fund Trading Strategy

This is the contention of a story in the October issue of MONEY magazine that said the rapid-fire trades were arranged in advance and sometimes amounted to trades over $100 million worth of mutual funds in a day.This was despite the fact that most fund prospectuses explicitly stated that they discouraged this sort of churning, according to “The Great Fund Rip-Off” report.

Begun by Wilshire roughly a decade ago, the report said the quick turnover of mutual funds was part of a hedging strategy, in which Wilshire would short sell index futures that were slightly overvalued and simultaneously buy a basket of at least 10 mutual funds. When the value of the index futures dropped, Wilshire would cover its position.  

In fact, Wilshire would hang onto the mutual funds for only a few days at a time, sometimes for as little as 24 hours, the MONEY story alleges.   This action ultimately harmed long-term mutual fund investors by creating higher trading expenses and the performance drag of excess cash.  

Additionally, at the time of the Wilshire’s hedging strategy – which the investment consultant ceased in 2002 – the company was in the business of helping large institutional clients select investment managers. Thus, MONEY asks the bigger question, was it a conflict of interest for fund companies that knew that Wilshire might (or might not) recommend them when its clients searched for money managers to make special allowances for Wilshire by permitting the rapid trading?

No specific mutual funds were named in the probe.  

Fund Probes

The MONEY report comes at a time when New York State Attorney General Elliott Spitzer has cast a wary eye in the direction of mutual fund trade execution, accusing some financial firms of trade execution skullduggery.   Most notable among these accusations has been hedge fund Canary Capital Partners, which the state’s attorney said engaged in illegal trading practices with several mutual fund companies, including making deals after the market had closed for the day (See Spitzer Fund Abuse Probe Pumps Out More Subpoenas ).

Spitzer said Canary obtained special trading opportunities with Strong Capital Management, Bank of America’s Nations Funds, Banc One and Janus Capital Group by promising to take substantial positions in various funds managed by these institutions.   Two types of trading violations have been alleged: Late trading, or buying mutual-fund shares after the market close at that day’s closing price; and timing, which involves taking advantage of market-moving events after the close of the market, when the funds’ daily price is set based on the net-asset value of the portfolio.

Additionally, Spitzer accused Canary of frequent in-and-out “timing trades” at the mutual funds, which, for example, take advantage of differences between closing prices of stocks overseas and the mutual fund’s later closing value. While this activity is not against the law, most mutual fund companies prohibit it as costly to other fund investors.

This in turn has led to a cornucopia of internal investigations by Janus, Strong and Prudential Financial (See  Ripples of Canary Fund Trading Probes Continue to Spread ).   Meanwhile investigations are also being conducted by the US Securities and Exchange Commission, and state regulators in at least two states including Colorado Securities Commission Fred Joseph who said he would be meeting with Denver-based Janus officials to find out more exactly what steps they plan to take in light of the probes.