Maybe you missed the latest mutual fund scandal. This one could still cost you money, even if you don’t own the funds in question.
Putnam Investments, a division of insurance company Marsh & McLennan, runs a bunch of mutual funds. At the last date of record, they had about $272 Billion in assets, spread across 12 million customers, about 700 of which were “institutional investors” — large accounts such as states and pension funds. As you will see, these figures are apt to drop rapidly. Keep in mind that the mutual fund industry as a whole is about $7 Trillion, and that 95-100 million Americans have money in mutual funds. This fund family is something like 3% of the industry.
As CNBC so politely puts it, “Putnam is facing a probe into improper mutual fund trading and losing some clients.” Two managers are accused of civil fraud, and that’s before the U.S. Attorney sent subpeonas. The SEC and Massachusetts are surely only the first to get in on this action; sabre-rattling between SEC Chairman William Donaldson and New York Attorney General Eliott Spitzer has already commenced.
The crux of the matter is something called “market timing.” By this we do not mean waiting for a stock to hit the “right price” before buying or selling — something totally legal that almost all stock owners do. Some people say the benign label of “market timing” whitewashes what it really is: fraud; stealing from the customer.
There have been a number of illegal and unethical “market timing” schemes used. One involves buying or selling after market hours, after some bit of important news has been released perhaps, at the closing price. Example: XYZ Corporation announces blowout earnings after the market is closed; Unethical Fund Manager Dewey Cheatum colludes with another fund to buy at the closing price (when nobody knew the news) so he can sell it in the morning for a few dollars profit per share. In a variation of this scheme, a manager uses international stocks — which trade at different hours than American stocks. Yet another “market timing” scheme involves detecting brief inconsistencies between where another fund is trading and its NAV (Net Asset Value, what it is worth), then exploiting this difference with rapid trades (scroll down) in and out of the fund.
Several Putnam employees are accused of illegal market timing, and more charges are likely to come down soon. This problem apparently was investigated internally as early as 1996, and little was done save to issue official policies declaring it a no-no. The trades in question are from 1998 and 2000, a period of time when the funds in question underperformed. Wouldn’t you be upset if your fund was losing money and yet the managers of the fund were pocketing $700,000 from personal trades? Wouldn’t you think they should put their money right next to yours and execute the best deals for the fund they are paid to run?
Some large investors think so. And they are speaking with their wallets. Massachusetts wants to pull $1.7 Billion. Rhode Island, $651 Million. Iowa, $594 Million. Connecticut, $277 Million. Well over a Billion from such sources as The Pennsylvania Public School Employees’ Retirement System, The New York State Teachers’ Retirement System, The Vermont State Teachers’ Retirement System and others. An even longer list of behemoth investors are “monitoring developments.” It could add up to some real money!
Frankly, the markets could get a bit bumpy. I seriously doubt Putnam has $4-5 Billion in cash sitting around to send to these big investors. That means they are going to have to sell stuff, and to sell that much is going to drive some prices down. That’s why this could cost you money if you own any stocks or stock-holding mutual funds. A savvy investor might make some quick money if he could take a billion or so worth of a top holding off Putnam’s hands.
And yet in the midst of all this, there are those who say not to drop these guys like a hot potato. When would be a better time? When all the institutions have gotten out, having forced the managers to sell absolutely everything at stupidly low prices and driving the value of all Putnam’s holdings down? When the NAV is so low that Joe Average can’t afford to sell his worthless holdings?
As if all this isn’t bad enough, remember that Putnam isn’t the only fund family whose managers stand accused of making trades that line their wallets and leave investors holding the bag.