From: Darrell Wiard [email@example.com]
Dear Ladies and Gentlemen:
My name is Darrell Wiard. I am a registered investment advisor, living in North Carolina. I have been an investment advisor since the early 90's. I only deal in mutual funds. I am a fee based advisor and I provide actual oversight of the funds and direct the exchanges for my clients. My business is small. I manage a total of approx $4 million dollars in approx 80 accounts. Some of my accounts are as low as $15,000 to $20,000, and I give these clients the same service as I do the few clients I have that are in 6 figures. I represent small investors. I am intensely interested in your rule proposal, and, in its present form, I am opposed to it. My comments are lengthy. I am only 6 hours away from DC. I would welcome the opportunity to talk with you further about this rule proposal and would come to DC if that would be possible. If you want to call me my telephone number is 252-745-8124. My internet address is firstname.lastname@example.org. Thank you for your consideration of these comments.
Let's start with your Background.
"Somefund investors take advantage of this collective relationship by frequently buying and redeeming fund shares." I must take issue with this first conclusion. In a $7 trillion dollar mutual fund market (so I have heard) I can not believe that there is not room for different investment perspectives. Further, where do I find that Long Term Investors are preferred in our statutes or laws over investors with shorter term investment horizons? Some of your conclsions do not make sense. If we assume that fund managers over the past 4 years had to hold extra cash to manage redemptions, given the fact that the fund managers lost large amounts of money over this time, wouldn't this have been to the advantage of all the shareholders of the fund?
"Some frequent fund traders seek short-term profits by buying and selling share in anticipation of changes in market prices, e.g., market timing." Again, it is a big marketplace. I have been in many businesses, including a law practice and 10 years in commercial real estate. I have always thought that buying low and selling high was a good idea. Taking a profit in any business is usually a good idea, as they can be very hard to come by. I am curious as to why buying low and selling high has transformed with respect to mutual funds into a bad thing? Is buying low and selling high against the law, or any securities code? Is making a profit against securities laws? Where is the time for holding a security mandated by any law or statute? Shouldn't time frame be up to the investor, not a regulator?
"Some have exploited pricing inefficiencies in which the price of mutual fund shares does not accurately reflect the current market value of the securities held by the fund, i.e., time-zone arbitrage." I call this the "international trade". It's been a long time since I took college economics, but isn't exploiting pricing inefficiencies at the heart of the securities markets? If we had a truly efficient market, there would be no range of bid and ask. Your time zone arbitrage argument is about as solid as the LTCM arbitrage (was that Black-Scholes?).
The"international trade" worked for a couple of years. The fact that it was a profitable trade does not make it wrong. Lots of relationships become profitable trades, but they all change over time. Is it wrong with oil prices going up to short airlines, or at least sell them? If you do sell them, are you being unfair to "LONG TERM SHAREHOLDERS" of airlines? Will it be wrong to sell financial stock and funds when Greenspan starts raising interest rates? Will the sale of such securities hurt those that don't sell (are they by definition LONG TERM SHAREHOLDERS?)? You bet ya it does, but isn't that what the market is all about?! Still, I can not see how that activity is wrong or needs to be regulated. That is investors making decisions.
From 2000 to 2003 the US was a leader and other markets followed. That was not hard to discover. But there were many years and decades that it did not work, and,even when it worked, it was not a "sure thing" as your "time-zone" arbitrage phrase implies. The "international trade" did not work in the 70's or 80's. From approx '73 to the late 80's Japan was the leader, we were the follower. The trade did not work. In the 90's the trade did not work. The US markets were advancing, but Japan and Europe (I think due to the amalgamation of the eastern european markets) did not follow. Further the US dollar was advancing versus other economies. The "int'l trade" just did not work. If the US markets went up big you could not count on and invest (or "arbitrage", as your usage implies) that the foreign markets would rise the next day. It just did not work. I tried. Really, extend your "time-zone" arbitrage thesis over the prior 30 years. I'll bet the "int'l trade"is a loser.
However, for a couple years it worked. From 2000 throught the depths of the bear market in 2003 it worked. The US led, the int'l mkts followed, and the currencies were either stable, or the foreign currencies were improving versus the dollar so that it became a good trade. It got so popular because it was the only trade during the bear market. Think about that. Money flocked to it because it worked. Very few other market sectors or investment styles worked. I tried to put my client's money to work many times during the bear market. Since you can not put in stops, I made mental stops. I would buy as the market or sector approached support, and put a mental stop under support. By doing so I only lost approximately 25% during the 3 year bear market. However, many times the market just plummeted right through the support. With your rule, I certainly had 5 or 6 occasions where my clients would also have lost your 2%, so they would have been down another 10% to 12%. In a bear market your rule will keep many investors from dipping their toes back in the market and taking risk.
But I digress, back to the "int'l trade". Because it was one of the few trades that worked during the bear market, the money flowed to it. We now know that companies bent their rules and allowed traders with large amounts of dollars to trade after hours and in manners that violate rules too numerous to mention. In some cases the funds must have waived their redemption fee policies for regular shareholders to attract these dollars. Now, however, I would bet that all that after hours, large dollar shenanigans have stopped. The pressure on the system, the abuses have largely ended. I hope you bring those that broke the law to justice. What I do not understand is that having discovered this abuse, having stopped this abuse (and I assume it occurred largely with international funds), how do you go to a universal rule affecting all mutual funds and shareholders who did not break any rules?
At the current point in time, the usefulness of the "int'l trade" is starting to wane. The market is doing its normal work, which is changing. Nothing works forever.If you bought overseas mutual funds on March 5th because the US was up, you got waxed on March 8th and everyday this week. Even long term buy and hold strategies are losing their stature. I can't number how many advisors sat on CNBC during the 90's and prophesied the doom and downfall of daytraders and market timers. If I remember the mantra correctly, the only way to be successful was to buy and hold for the long term and no other approach would work. Well, if that was true, market-timing and your "time-zone arbitrage" would never have been a problem if it did not work. Those trying it would have gone away after they lost their money. But the trade did work, active management of mutual funds made or saved those who took advantage of itmuch of their capital, whilelong term shareholders in everything during the bear market lost big. The true buy and holders during the bear market lost 40% to 80% depending on their positioning, not the 20% to 25% losses that an active management mighthave returned. The active management was not evil,the evil was not that it was a profitable trade. The evil was that some greedy managers and funds broke there own rules and allowed large dollars to trade where normal shareholders could not. For this specific evil, which the market is going to correct before your rule is ever implemented, you are proposing such a drastic, universal solution,that I am astounded you have got this far.
"Many funds have taken steps to deter excessive trading or have sought reimbursement from traders for the costs of their excessive transactions." True, but many have not, and have no need of it. Let's just examine some of the funds that do not need this draconian rule, which I am sure you would describe as necessary to save the industry. Well, for sure, money market funds do not need a mandatory redemption rule such as you have proposed.They should definitely be exempted. Common portfolio management at times demands that they be actively used.You do not make money in a "trade" sense in a money fund. In fact, many money marketfunds these days are losing money. If you use a money market for depositing your 401k or other deposits into your mutual fund, you want to move it out as soon as possible if you feel the risk is not too great. Adding a 2% fee on afund already losing money on a daily basis is drastic. So let's exempt money markets.
Sector funds do not need restrictive redemption requirements. I mean, some sector funds actually allow trading on an hourly basis. How can you now extract a 2% fee from such funds and mandate a 5 day hold.I have rarely seen anyone suggest that sector funds anda long term buy and hold strategy were compatible. Sector funds require active management to be effective used in a portfolio. Fidelity, which allows the hourly trading of sector funds, does require a .75% fee if you sell their sector funds within 30 days, and I think they do quite well with this policy.In a sectorfund, which ismore narrowly focused, the investor needs to be in control of when they buy and how long they hold. Adding an artificial cost and consideration to the equation with your 5 day holdor 2% is extremely burdensome and costly to the sector fund investor. I can not imagine that the funds offering sector funds are clamoring for your "protection."
Fund Families Designed from the outset for Active Traders do not need or seek your protection. Rydex funds and ProFunds, to name 2 fund families, are specifically designed and welcome active trading. They are gaining in popularity among investors and money management professionals. Rydex recently informed me that they had surpassed over $10 billion in assets. They are explicitly clear that daily exchanges are welcome and their fund and management expenses are not exorbitant, nor are they abused by active traders. Since they are clear upfront about their policies, no long term buy and hold shareholder is hurt from their exchange policy. They have notice of it. Further, when it comes to index funds and sector funds, which they basically are, even with their exchange policy, they are the best provider of these funds in the industry. Why? Their costs are acceptable, their performance within their sectors and indexes are good, and they do not have restrictive redemption fees. It is up to the investor to determine when to buy and when to sell, how much risk they want to take. An investor can sell for no other reason than it is their money and they want to sell They clearly do not need your rule, and the active investors that use these fund families may very well be excluded from mutual funds if you drive them out of business. Here is a novel thought. Make each fund family declare in its prospectus if it welcomes short term traders and investments. That gives long term shareholders the knowledge and ability to move to funds that do not welcome short term investors if they so desire.
If the basis of your proposed rule is really valid, then the funds which welcome short term investors will do worse than those that allow only long term investors, and fall out of favor or close. Clearly forewarn investors through the prospectus if short term trading is allowed. But then, allow the market to determine which investment approach is best. Isn't disclosure and an informed investor the goal, not defining preferred forms of investing? The best situation for the investor in mutual funds is a wide array of choices and the ability and freedom to implement whatever strategy the investor feels is best at any point in time.
EventRisk Most prospectus that I read these days are leaving out in their discussion of risk, a new and important category > Event Risk. After 911, and even after yesterday, it is not unreasonable for an investor to want to move quickly to protect his invesment dollars if they are worried about increased risk due to terrorist acts or other similar events. In your list of exceptions, I feel an investor should be able to move his monies to a money market or safer investment without incurring your proposed fee.The problem is whatconstitutes an acceptable level of risk may be different for each investor. Merely raising the threat levelfor some investors could cause them justifiably to change their investment posture. I made some purchases last Friday for my clients. I considered very carefully yesterday whether I should sell some assets due to the actions in Spain yesterday. IfI had decided to sell these assets, as I am sure many did yesterday, I do not feel that your 2% fee would have been appropriate.
Should the rule permit, rather than require, funds to charge a two percent redemption fee on the redemption of all securities held five days or less? As I discussed above, because the mutual fund industry markets such a wide array of funds, each fund should be able to decide whether or not to charge such a fee with the proviso, that if they do not charge such a fee they should disclose in their prospectus that such a policy means the fund is available to investors with both long and short term invesmtment approaches. Money market funds, sector funds, index funds, and fund families designed specifically with short term trading in mind, i.e. Rydex and ProFunds to name two, should not be punished with a mandatory rule.
Is two percent the appropriate level for the mandatory redemption fee? Should it be higher or lower? To imagine that one could pick an "appropriate level" for a redemption fee that would applyto ALL FUNDS I find to be just laughable. Fidelity has been fine for years with their .75% fee on sector funds. They vary their time and % on international funds. They do not see any need for a fee at all onmost of their funds which invest in US assets. You just can not charge a fee on money markets. To use Fidelity's mutual fund brokerage network, to change from one family to another, you sell to the core money mkt acct and then buy the fund in the other family you are changing to. This is not a five day hold procedure. Some funds, who are truly long term, require a minimum hold of a year and do not even speak of a fee. I think it is impossible to say that there is one level for a redemption fee that would be applicableand fair ona mandatory basis for all funds.
We request further data on the magnitude and types of costs that funds bear as a result of the active24 trading by a small percentage of shareholders.nbsp; The expenses for fund families that allow active trading and disclose this fact upfront do not approach 2% per year on an annual basis. 2% per trade would be absurdly high. See the annual statements for Rydex Funds and ProFunds. I have contacted these companies and know that they have been in continuing discussion with you.
Does the two percent level approximate the transactional costs that funds incur as a result of frequent trading? I have been advised that the transactional costs are
the merest fraction of a percentage in fund families allowing active trades. 2% per transaction is an incredibly high number.
Would a five-day holding period be sufficient to deter frequent trading, especially frequent trading due to abusive market timing? The financial markets are moving faster, not slower. Nothing you are contemplating will change that fact. Whatever holding period you use will not deter frequent trading. Those that want to actively manage their money will simply move to another format, such as ETF's, hedge funds, Spyders, etc. These days a bear market can occur in five days. Witness this week from March 5th to March 12th. Any investor,no matter theirtimeframe or style of investing, whether long term or daytrader, could have with good reason decided to sell a fund they bought last Friday. If your2% fee interfered with their decision on Monday or Tuesday, you justcost them another 4% to 10% is they were in a sector or smaller index fund. Doyou bear any responsibility for their gains or losses? NO. The investor has to make those decisions. They should be able to do it as they see fit, andasthey see the market and the attendant risk,and your decision as to what is proper should not be part of their consideration.
Should the rule contain a special provision addressing account transfers within the previous five days, e.g., rollovers from a 401(k) plan to an Individual Retirement Account, to prevent the imposition of the redemption fee in those circumstances? There are so many special provisions that could apply that this rule would start to resemble the tax code for complexity. Again, educate the investors, through clear language in the
prospectus (I refer you again to Rydex and ProFunds)
C. Smaller Investors Your whole discussion on deminimis and small investors I find to be mind boggling. This rule would be a totaladministrative fiasco for the fund companies. Who is in, who is out, who gets exemptions from the rule? What is a reasonable amount? The fact is the reason for this rule is the hundreds of millions, even billions that was traded after hours by certain funds in contravention of their stated policy. An effective prosecution of those people will do much more to eliminate this abusive policy than your rule. However, if you want to make it effective and easier to apply, make the mandatory redemption fee apply to any transaction overa million dollars, or $500,000 or some much larger number. That is going to stop the hedge funds and abusive traders and omnibus accounts.
The rule also would apply to short-term transfers among subaccounts within variable annuity contracts.18 Variable annuity contracts do differ on exchange rules within the subaccounts. However, many contracts allow as a prime feature of their contract "Unlimited Daily Exchanges". Since this standard is known upfront when the investor enters into the contract, how are long term investors hurt is the contract holder exercises his judgment under the contract to exchange his shares. Shouldn't the insurance company be able to offer the investor the ability to manage his monies as he sees fit? If you, by impostion of this rule, cancel this right under the annuity contract, will you also allow the investor to cancel the contract without paying any back end fee to the insurance company. I mean, if the investor entered into the contract for the specific purpose of being able to actively manage his monies and you nullify that, shouldn't you also provide rules for termination of the contract that do not cost the investor?
E. Exceptions So, after all this, I find I was not crazy, and neither were you. Still, I find the proposed rule to be too little too late, and horribly complicated and costly to administer. The "int'l trade" is over. The abusive after hours traders have stopped and are running or hiding. I hope you get every one of them. The effectiveness of the "int'l trade" is waning. The market is taking care of that. Some other trade will take its place. It always does.
Still, your rule will play havoc with much of the fund industry, the 401k administrators and the variable annuity companies with its administrative burdens. I found over the past 15 years that the fund companies were effective in applying redemption fees and exchange restrictions where necessary. Invesco, and now AIM had a limit of four exchanges per fund per year, but no minimum hold. Basically one trade per fund per quarter. That worked. I hated to give up a positon I entered, but if the market changed and I needed to get out, that should be a function of the investor, his risk tolerance and the market, not your artificial and widely applied fee. Fidelity effectively managed their sector funds and international funds with redemption fees they felt appropriate. Rydex and ProFunds are doing a great job for all investors, not just short term investors, but they are explicit in their prospectus that they welcome short term investors. The best thing you can do is make each fund state clearly whether they want short term investors and then live by that. With respect to 401k plans and variable annuity plans, the exchange policy is negotiated in the plan with the employer and/or the investor. They should be able to incorporate funds that allow them to fulfill their obligations to their investors, and opt out of all the reporting that you propose.
Fair Value Pricing From my perspective fair value pricing is a joke. Like death and taxes, the sun rises in the east and sets in the west. Therefore, as long as the US market is the strongest market, since we close last, the direction of our markets will effect foreign markets the next day. However, this relationship is not certain. I have followed with interest the funds that "fair value price" and it is interesting to see how often they miss. The US goes up big on a reversal day, when foreign markets are down. XYZ Int'l fund manager, who uses fair value pricing, instead of giving the nav of his fund, say $10.50, down $.15 per share, adjusts it to $10.80, adjusting for the rise in the US market and the anticipated rise in the foreign market the next day. Some semiconductor company announces after hours bad earnings and the asian countries do not rise they fall further. Now the manager must adjust his price from $10.80 clear to the new correct nav, say $10.40, a drop of almost 4% in one day. In my experience an artificial price is inherently inefficient, and the sharpshooters will start playing it. Don't call it "Fair Value", just call it artificial. It is more honest and more accurate, and isn't disclosure the goal you are shooting for?
Summary I still do not understand where you get the authority to decide that one manner of investing versus another deserves protection under the law. Isn't the market the appropriate place to decide competing investment approaches. I contend that the market is large enough, and diverse enough to encompass many different investment approaches. The funds can implement where they deem it necessary redemption fees and exchange limitations. I can not see where a mandated universal policy makes sense. This is particularly true when the complexity of the market and the exemptions you are already discussing practically insure another administrative boondoggle. Mandate disclosure of whether the fund accepts short term trading accounts and make sure they live up to that. Over time, I will bet that most mutual funds will allow them for competitive purposes. Don't hamstring the small, everyday investor who has his life savings in a 401k, variable annuity or similar mutual fund account from making the investment decisions he sees fit. Thank you.