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Sun, Nov 16, 2003 - Page 12 News List

Families of mutual funds tend to play favorites: study


A new study has concluded that mutual fund families often play favorites with their funds. They do this, it says, by giving certain funds extra shares of the most-sought-after initial public offerings and by arranging for funds in a family to take the opposite sides of certain trades, to the advantage of a chosen few of those funds.

The study, "Favoritism in Mutual Fund Families? Evidence on Strategic Cross-Fund Subsidization," was conducted by two finance professors at French business schools, Jose-Miguel Gaspar of Essec and Massimo Massa of Insead, with one of Massa's graduate students, Pedro Matos.

The research used a database of all actively managed domestic equity funds in the US from January 1991 through June 2001 and focused on the 50 largest fund families, whose combined assets amount to more than 80 percent of assets in such funds.

The researchers found that, because of favoritism, some funds do better than they would otherwise, while others perform worse. These conclusions are based on a statistical study of fund families as a group.

The researchers found that executives of fund families used several approaches to favor certain funds. In one strategy, the highest-fee funds in a fund family, on average, received far more shares of initial public offerings than those with the lowest fees. And funds with the best year-to-date performances also received a disproportionately large share.

This pattern was even more pronounced for IPOs whose prices jumped the most on their first day of trading. These were presumably the IPOs for which market demand was greatest, and therefore could be most expected to increase the favored funds' returns.

The researchers attributed an even bigger impact to a practice known as opposite trading, which occurs when funds within a family take the opposite sides of trades. That can happen when the manager of a favored fund wishes to buy or sell an illiquid stock, Massa said. The manager might otherwise think twice before making these trades, because the fund's own buying or selling could hurt prices. But by having other funds in the family buy when favored funds are selling or sell when the favorites are buying, the manager of a favored fund can trade with minimal impact on prices.

Over the period studied, the stocks sold by favored funds generally lagged behind the market after they were sold, and the stocks they bought generally outperformed. As a result, opposite trading had the effect of transferring some of the returns of out-of-favor funds to their favored brethren.

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