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Money market churn points to evidence of market timing

Review finds $70.7-billion transferred into money market funds of four companies

The four mutual fund companies under scrutiny by securities regulators had huge transfers in and out of their money market funds during the same period that their international stock funds showed telltale signs of market timing.

Between 2000 and 2003, $70.7-billion was transferred into the money market funds managed by Investors Group Inc., CI Fund Management Inc., AGF Management Ltd. and AIC Ltd., according to a Report on Business review. During that same period, another $69.5-billion was transferred out of these funds to other funds within the same companies, the study shows.

The pace of activity in the four companies' money market funds closely matched the rapid, in-and-out trading in their international funds, providing further signs of market timing.

A Report on Business investigation published in June showed that hedge fund players and other market professionals were darting in and out of dozens of international equity funds managed by Canadian companies. Investors Group, CI, AGF and AIC had more funds than any other company with signs of market timing.

The latest study reveals that the money market funds were the conduit for the market pros, industry sources said. They simply moved cash back and forth from a company's money market fund to one of its international equity funds, they said.

"The activity in the money market funds is just the flip side to the trading in the international funds," said a senior mutual fund executive who asked not to be named. "If [the market timers] are not in the international funds, then they're in the money market funds."

Trading was examined in the money market funds of Investors, CI, AGF and AIC because the companies are in settlement talks with the Ontario Securities Commission's enforcement arm. As part of the proposed accord, the companies have agreed to pay $200-million in restitution to investors, industry sources have said. An announcement could come as early as this week.

The four companies collectively manage $116-billion in assets, ranking them among the biggest players in the $473-billion industry.

Officials at all four companies declined to comment.

Market timing is not illegal. However, in accepting responsibility for other people's money, fund managers have a fiduciary duty to act in the best interests of all of their investors.

Market timing is not in the best interests of long-term investors because the practice reduces a mutual fund's returns.

Market timers attempt to exploit price discrepancies in international funds, where events after overseas markets close can make their prices out of date.

Rapid, in-and-out trading totalled $220-billion between 2000 and 2003 in dozens of international funds managed by Canadian companies, the investigation found. It all but stopped in September, 2003, after regulators in the United States launched a broad crackdown on market timing and other controversial trading practices.

Comparisons of activity in the four companies' money market funds and their international funds were most striking when the monthly figures are examined.

For example, during the first three months of 2003, $9-billion was transferred in and out of CI's money market fund. During that same period, $9.2-billion was also transferred in and out of its international equity funds that showed signs of rapid trading.

This is in stark contrast to the last three months of 2003, when activity dropped off sharply. Transfers in and out of CI's money market funds dwindled to $324-million from October to December of 2003. In its international funds, transfers shrank to $515-million.

CI had 32 funds that showed signs of market timing, well in excess of any other company in the study.

While the practice flourished on Bay Street, it was rarely acknowledged publicly by industry players. Executives at only two fund companies, CI and AGF, have openly talked about the prevalence of market timing in Canada.

"There were people trading in and out of funds, just like there were everywhere," William Holland, chief executive officer of CI, said in an earlier interview.

Other industry players have either said nothing or gone on the offensive.

Tom Hockin, head of the Investment Funds Institute of Canada, a trade group for the industry, said at its annual conference in September that the combination of five years of poor markets, regulatory scrutiny and "hostile" media coverage has produced a "perfect storm" for the industry.

Fund managers monitor cash coming in and going out daily. As a result, there is no way the huge influx of cash moving in and out of their money market funds could have gone unnoticed, industry sources said.

The trading activity was out of proportion when compared with assets under management in the companies' four money market funds. In 2002 alone -- the same year market timing activity hit a peak -- their combined assets totalled just $3.4-billion. The money market funds had a churn rate of 1,754 per cent that year.

Churn rates -- a measure of all the money flowing in and out -- were calculated by adding together sales, redemptions and transfers in and out of a fund as a percentage of its average assets.

A churn rate of 100 per cent means that cash equal to the dollar value of average assets flowed in and out of a fund that year. Transfers among funds within the same company accounted for the lion's share of the churn.

The activity in the companies' money market funds was also staggering when compared with that in the study's benchmark funds. Money market funds managed by TD Asset Management Inc. and Fidelity Investments Canada Ltd. were used because both companies have had procedures in place for years to make market timers unwelcome in their funds.

Between 2000 and 2003, $13.4-billion was transferred in and out of the benchmark money market funds -- a fraction of the $140-billion in transfers in the four other companies' funds.

Sources close to the talks between the four companies and the OSC said the regulator wants executives to acknowledge as part of the proposed settlement that they should have provided a higher standard of care to the thousands of investors who entrusted their life savings with them.

Investor advocates say the commission should levy fines against the companies in addition to having them make restitution to investors.

"Investor restitution is vital, but the real issue is a breach of trust," said Ken Kivenko, author of a mutual fund newsletter. "Clearly, fund trustees breached their fiduciary duties. . . . They must be held to account by the regulators."

However, industry sources said the commission has no plans to fine the companies. Michael Watson, the OSC's head of enforcement, declined to comment beyond saying: "Our focus throughout this has been the investors."

High churn rates in money market funds

The four mutual fund companies under scrutiny by securities regulators - Investors Group, CI Fund Management, AGF Funds and AIC - had unusually high rates of churn in their money market funds between 2000 and 2003. Transfers in and out of their money market funds to other funds they managed accounted for the lion's share of activity, providing a strong indication of market timing. Sales and redemptions made up a much smaller portion of the cash flows. By contrast, activity in the benchmark money market funds managed by Fidelity Investments Canada and TD Asset Management was much lower. Fidelity and TD were chosen for the benchmark because each company has for several years had procedures to dissuade market timers. The Fidelity and TD money market funds had much lower trading activity, a pattern that reflected activity in their international equity funds.

TransfersTransfers
SalesRedemptionsinoutChurn
2000
Four companies89.3%81.7%434.1%465.6%1,070.7%
Benchmark120.1121.343.150.1334.7
2001
Four companies81.287.4679.2641.61,489.3
Benchmark108.789.426.722.5247.5
2002
Four companies59.670.4822.8801.61,754.4
Benchmark76.088.220.015.8200.0
2003
Four companies49.880.9312.2306.1749.0
Benchmark68.178.118.418.9183.5

Sales: Sales consist of new money coming into a fund company.

Redemptions: Redemptions consist of cash going out.

Transfers: Money that moves from one fund to another within the same company.

Churn: A measure of all the money flowing in and out of a fund. Churn rates were calculated by dividing each fund's total money flows for the year by its average assets. A churn rate of 100 per cent means cash equal to the dollar value of average assets flowed in and out of the fund. The percentage figures for sales, redemptions and transfers in and out indicate their portion of the overall churn rate.

In-and-out trading

Transfers in and out of the four companies' money market funds closely matched transfers in and out of their international funds that showed telltale signs of market timing.

$billion

Transfers in and out of the four companies' international equity funds that showed telltale signs of market timingTransfers in and out of the four companies' money market funds
200018.523.1
200134.439.3
200260.454.9
200318.122.9

© 2007 The Globe and Mail. All rights reserved.

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