What's So Hard about a Hard Close?

The mutual fund market-timing scandal is now eight months old, and the threats posed to investors by abusive trading may yet be fading in some people’s minds. We’re starting to get pushback from those who value convenience over shareholder protections.

A couple weeks ago two members of the Senate Finance Committee warned that measures to prevent market-timing shouldn’t get in the way of 401(k) investors’ ability to make same-day trades in their funds. I’ve also heard that some plan administrators are saying they would switch from mutual funds to separate accounts if the hard close plan took effect, in order to provide maximum convenience for employees who value quick trades above all else.

The problem with this thinking is that it's what got us into the current mess. Some investors want instant fund transactions because they’re used to getting instant stock trades. The problem is that brokers and fund companies have gone to great lengths to create the illusion of instant trading in funds without setting up the systems to do it. If I buy a stock in my 401(k), the firm that runs Morningstar’s 401(k) will execute the trade with lightening speed. However, if I opt to move some money from a bond fund to a stock fund, the firm will sit on that order and wait until the end of the day and then aggregate all its orders before sending them to the fund company.

If the firm wanted to, it could spend the money to quickly gather up all the orders so investors could place fund orders until shortly before the closing bell. Alternatively, the firm could invest in the technology that would create a time stamp on the initial order so fund shareholders can be assured they’re not being ripped off by late traders. Morningstar managing director Don Phillips suggested in his proposal that funds institute a hard close for all accounts that can’t provide this time stamp, and that idea makes perfect sense to me.

However, brokers, plan providers, fund companies, and some investors have grown comfortable with the veneer of convenience and safety and they say that’s not enough. The funny thing about all this hand wringing is just how little investors would be sacrificing with a hard close. Funds are designed as long-term investments, so it shouldn’t matter whether you get in at Wednesday’s close or Thursday’s. Moreover, if I’m switching between a bond and a stock fund, a one-day delay is just as likely to help as hurt because that bond fund might outperform the stock fund in that single-day period.

The one thing that has a real impact on investors’ 401(k) returns is how long it takes for the money to go from the employer to the fund. Today employees often have to wait between one and four weeks before their money hits their funds. Yet no one is calling for faster execution on that end.

This scandal largely happened because savvy hedge fund managers were able to exploit the gap in perception and reality when it comes to executing fund trades. The SEC should keep moving ahead with all due speed in closing that gap. If that means I have to get my fund changes in a couple hours ahead of the bell, that’s fine with me.

Gee, Thanks Big Board
Mutual fund investors have a big stake in reforms at the New York Stock Exchange because questions have been raised about whether the specialist system is providing the best execution. That’s why it’s a little disappointing to see  Hewlett Packard (HPQ) CEO Carly Fiorina appointed to an advisory panel of the NYSE. Investors in Scudder funds may recall that Fiorina leaned on Scudder parent  Deutsche Bank (DB) to vote its fundholders’ shares in favor of the HP-Compaq merger. In other words, she asked them to toss aside their fiduciary duty in order to serve the interests of a big investment-banking client.