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Bad timing

In its Market Timing Guidelines, the Investment Management Association makes a case for all investors, whether they are fund managers or private investors, to receive the same level of information about a fund’s portfolio at the same time lag.

These portfolio disclosure proposals are based on the IMA’s belief that the flow of privileged information to some categories of investor, such as multi-managers, could be abused by market-timers.

Although not illegal in the UK, market timing is a trading strategy which has the potential to disrupt the natural movement of stockmarkets and can make the cost of buying and selling shares more expensive. It occurs where investors may be aware of something which will effect share prices but knows this information is not reflected in the latest valuation. If a market is closed, the investor may act upon their knowledge when it reopens or use it to their advantage while trading on markets in other time zones.

Market timing has been a problem in the US but recent investigations by the FSA found little evidence of market abuse in the UK. However, the IMA believes it is helpful to have guidelines for fund managers to deter market timing. The problem is that making the same information available to all investors could be expensive, so fund managers might decide to publish the details of their portfolios less frequently. If this happens, fund of fund managers will face problems in accurately assessing risk and making the right asset allocation decisions as they would not have access to the most up to date information.

Gartmore Portfolio fund manager Marcus Brooks was involved in the initial discussions with the IMA and reveals that it has softened its original stance. He says: “The IMA wants a consistent policy for all investors and we have no argument with that. But the original idea was rather prescriptive and I was quite worried. We need to know the risks involved in a fund. That is what multi-managers offer clients, another level of risk assessment.

“At one point, the IMA was talking about showing just the top 10 holdings in a fund on a regular basis. This didn’t make a lot of sense because if the fund was investing in, say, the UK, the concentration of the All Share index would mean these holdings would probably include BP and Glaxo.”

Brooks points out that the level of disclosure varies across the management groups and that it is up to them to take a consistent approach. He thinks that the revised proposals are unlikely to create any real problems. Other multi-managers believe the implications of the proposals work in favour of their particular investment approach.

Multi-manager specialist Miton Investments, which is starting to make its funds of funds available to IFAs, does not use benchmark indices. Its fund managers have the freedom to invest only in funds that are exposed to sectors they like.

Miton fund manager Sam Liddle thinks the IMA’s portfolio disclosure proposals will only be a problem for multi-managers who use benchmarks. He says: “We have faith in the managers we invest in and do not feel that we have to know exactly which stock bets they are taking. But when the fund of funds is tightly correlated to a benchmark, the fund managers would have to know the constituents of the underlying funds to get the tracking error right.”

Where the underlying investments are segregated mandates rather than existing funds, the IMA’s proposals could be even less of a problem. Abbey’s five multi-manager funds operate on a manager of manager basis rather than a fund of funds, with Abbey providing a framework of risk controls and performance targets for 12 management groups.

Abbey head of client investment and multi-manager development John Kelly feels that the issues surrounding the portfolio disclosure proposals draw attention to the inevitable distance between funds of funds and the underlying investments, which has always been a concern for Abbey. In Kelly’s view, manager of managers will increasingly have the edge over funds of funds because of lower costs, more control and greater information flows.

Kelly says: “We have direct relationships with the fund managers instead of sharing them with other investors. Our multi-manager funds have had good performance in their first year. This can be taken with a pinch of salt as it’s only a year but it’s been a testing time that has generally vindicated our approach.”

However, Brookes at Gartmore believes the manager of managers’ approach will have the edge over funds of funds in theory but not in practice. He explains: “It is not in anyone’s interests to become less transparent. Retail groups want investors to invest in their funds and if they thought people weren’t investing because of infrequent disclosure, they wouldn’t do it.”

The consensus among fund managers is that the way to discourage market timing is to remove its profitability through the application of dilution levies to big trades. Dilution levies are paid into a fund to ensure fund performance is not adversely affected when the volume of sales and redemptions rises above a trigger point. However, these trigger points are published in prospectuses and the IMA feels market-timers would simply trade below them. It wants fund managers to review their trigger levels at regularly and to draw up legal contracts with fund supermarkets if dilution levies will not be applied to their transactions.

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