NEWS ANALYSIS

Leader of fund used market timing to bleed away millions in profits

By FLOYD NORRIS New York Times

Sunday, November 16, 2003

Who would have thought that Gary L. Pilgrim would seek to profit at the expense of the investors whose trust made him wealthy?

As a star money manager during the 1990s, Pilgrim was a growth- at-any-cost investor. “I frankly don’t believe that I’ve lost any serious money because of overvaluation,” he said in 1996.

Later on, his customers would lose plenty. But Pilgrim did quite well.

We now learn that a hedge fund in which he was an investor was making money from market timing trades in PBHG funds — including, according to one person briefed on the findings, the Growth Fund run by Pilgrim.

The market timing trades started in March 2000, just as the fund headed south, and continued through December 2001, a period when investors in the fund were losing billions of dollars.

Old Colony, a South African insurer that bought the PBHG funds near the top in 2000, said Thursday that Pilgrim would repay to the funds the money he — but not other investors in the hedge fund — made from those trades.

Long term, market timing hurts

Market timing trades can hurt long-term fund investors. They force fund managers to buy and sell stocks to keep up with the fund flows, thus raising fund expenses. They can allow investors who leap in and out to share in profits that were really earned by other investors’ money. But they also boost investment advisory fees, which are based on fund assets.

Until late 2001, PBHG did not try to discourage market timers. Was that because Pilgrim was profiting from such trades?

Pilgrim and Frank Baxter, who approved the market timing, now have been forced out of the company they founded. They made hundreds of millions of dollars while investors lost billions.

In March 1993, PBHG had one fund, with $6 million in assets. Seven years later, its 14 equity funds had $15.8 billion in assets.

For the 11 years through this past March, investors in the PBHG stock funds lost a net $3.3 billion. Over the most recent eight years — earlier numbers were not available — the company collected $499 million in investment advisory fees. Half of that money came from the PBHG Growth Fund.

Along the way, Pilgrim and Baxter found two ways to cash out. In 1995, they sold their management company to United Asset Management for stock in that company. They got to keep a share of the revenue from running the funds. Then in 2000, after Old Colony took over United Asset Management, it paid hundreds of millions of dollars to the men for their share of the revenue.

It was in 1995, the year that United Asset Management made the men rich, that Pilgrim invested in the hedge fund. By 2000, Pilgrim was very rich. But he wanted more, and he pushed to let the hedge fund do market timing trades.

Do investors have feathers?

All too often, it now appears, mutual fund managers viewed fund investors as chickens to be plucked. The current scandals involve market timing and late trading, but there are other practices — still legal and still practiced by many funds — that are dubious. One is the shifting of expenses for such things as quotation terminals to the fund shareholders, rather than assuming that the millions of dollars paid for investment advice might pay for such equipment. Another is the way funds make existing shareholders compensate brokers for selling the funds to new investors.

Now we have the specter of competing law enforcement agencies. The risk is that squabbling regulators will slow the arrival of needed reforms.