Britain’s largest unit trust companies have been targeted by specialist market traders who attempt to skim off profits that might otherwise go to small private investors, using a practice called”market timing”.
A Guardian survey of Britain’s top 10 unit trust providers shows many managers concerned that they have been hit by such sophisicated traders. Many reveal they have been forced to take action to guard against them.
The market-timing scandal – where hedge funds trade and in out of mutual funds to make quick profits – was first exposed in the US, where New York attorney general Eliot Spitzer has launched a high- profile and hard-hitting investigation into the practice.
There are escalating fears that the practice is equally common in the UK. The Financial Services Authority has just launched an investigation into similar practices in Britain and is scrutinising data received from major fund management groups to establish the extent to which it takes place.
The FSA inquiry is understood to be focusing on funds which are more than 50% invested overseas. Open ended investment companies, in which pounds 143bn is invested, are said to be particularly at risk.
If evidence is found of widespread profit skimming by hedge fund traders, it would be a huge blow to the reputation of the unit trust industry. After scandals over the selling of pensions and endowments, a furore on market-timing could further undermine savers’ confidence in financial services.
Major fund management groups admit to being con cerned about market-timing activities. Unlike the shares in which they invest, unit trusts are only priced once a day which provides professional traders with opportunities to make profits on underlying price movements.
Standard Life Investments, a manager in the top 10 rankings, confirmed that it had been approached “a number of times by US- based hedge funds”.
A company spokesman said: “On the first occasion, before we appreciated what they were going to do, we accepted a few trades. But the potential [risk] to other investors was quickly identified by our risk manager and further transactions were discouraged. We have declined all further proposals and will continue to do so. No retail funds were affected.”
Another top 10 manager, Schroders, said it had been concerned in late spring that some of its Luxembourg-domiciled funds were exposed to market timers.
“Schroders took steps to protect its existing clients from market- timing activities,” said the fund manager. It changed the time of day when the funds were priced and the process used to price the funds.
Gartmore, another top 10 unit trust company, said: “We actively discourage market timers from entering any our funds and whenever we have identified them, it has been our policy to actively seek to remove them from our funds.”
Fidelity, the country’s largest unit trust manager, said it also did its best to discourage hedge fund market timers, while M&G, the investment arm of Prudential, said it had never “knowingly permitted” market timers to use its UK funds.
Unit trusts have measures that they can implement to try to deter market timing. They can use fair value pricing – which allows them to alter the price of the unit trust if there has been a lot of movement in the underlying market. They are also able to apply an extra charge – known as a dilution fee – on unusually large trades.
Scottish Widows would not be specific about whether it suspected its funds were being used by market timers but said that it had used dilution levies “on a number of occasions” this year.
Some other big unit trust managers insisted they had not been used by market timers. Insight Investment, part of HBOS, said it found “no evidence of inappropriate trading”, while Threadneedle and Invesco Perpetual said they did not believe their funds were being used by market timers.
