New research shows that “portfolio pumping” still occurs at mutual fund families.
Larry Swedroe, Director of Research, The BAM Alliance
Portfolio pumping—also known as “painting the tape” or “leaning for the tape”—is a market-manipulative strategy that mutual fund and hedge fund managers use to mark up their holdings at the end of the quarter by purchasing stocks they already hold (especially small stocks, whose prices are easier to move).
The strategy, which has been well-documented, can lead to inflated portfolio values and misleading returns. Since the publication of these findings in the 2002 study “Leaning for the Tape: Evidence of Gaming Behavior in Equity Mutual Funds,” portfolio pumping activity has garnered attention from the media and regulators. The result has been a substantial decrease in this activity because it draws the eye of the SEC.
The literature also documents that fund families allocate more shares of hot IPOs to new, smaller funds, where the allocation can have an outsized impact on returns. Fund families know these strategies are successful in attracting assets because it’s well-documented that investors chase performance, and the relation between future inflows and performance becomes very convex when performance is high.
New Research On Pumping
Pingle Wang contributes to the literature on performance pumping by mutual funds with his March 2017 study, “Portfolio Pumping in Mutual Fund Families.” Using Center for Research in Security Prices data, Wang tested to see whether the manager of a fund complex was assigning managers of nonstar funds to buy stocks heavily held by the star funds (funds in the top quartile of performance) in the family to pump the portfolio of those star funds.
Wang noted: “The manager of the fund complex has incentive to do so, because the flow attracted to the company is convex with the performance. Moreover, other non-star funds in the family benefit from the spillover effect because of the superior performance of their star funds.”
While he found that, after 2002, no evidence exists of portfolio pumping at the individual fund level, at the fund family level, Wang found:
The publication of findings regarding individual fund pumping drew the attention of the SEC, which led to fund families finding another way to pump up the returns of their star funds and mislead investors.
Just another reason, among many, for investors to use passively managed funds, which have no reason to engage in such behaviors.
This commentary originally appeared July 17 on ETF.com
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2017, The BAM ALLIANCE