There are not too many times that one feels a twinge of sympathy for mutual fund companies, but this may qualify as one of those rare occurrences. Apparently a large number of employees at American Airlines were following an investment newsletter and making fairly frequent trades based on its recommendations. This caused so much consternation at T. Rowe Price that they changed their policy and halted some trading in their mutual funds:
It’s an unusual move that has the affected investors crying foul—but it also underscores how the plans of long-term investors can be affected by the gyrations caused by short-term market players. The problem, according to T. Rowe Price, is that the offenders were making their trades more or less in tandem, at the recommendation of a newsletter. There’s nothing illegal about that, but that kind of mass movement can force fund managers to buy or sell assets at less-than-favorable prices.
So what?–you may be thinking and I am inclined to believe you are not alone in asking that question. But there is a question of fairness involved and though the employees are doing nothing wrong and certainly nothing illegal it does have an effect on all of the other shareholders. Now, the same can be said of any mass selling period which are quite common during bear markets. And it highlights one of the weaknesses of mutual funds in general. During times of large selling many money managers may feel that there are bargains galore, but because of the structure of mutual funds they are forced to sell when in reality they might be buyers. On top of that, there are some assets that are just not as big as others and that can have a real effect on shareholder value:
…and Paul Burger,co-publisher of the 401(k) newsletter EZTracker, told Horowitz the trading ban was probably triggered by his publication’s April recommendation that investors sell shares of a T. Rowe Price high-yield bond fund. (T. Rowe Price declined to confirm that, but Horowitz’s documentation from other sources appears to back it up.)
Now, the junk bond market isn’t really that small, but the point is fair. Bonds tend to trade in an opaque fashion as it is and it is not hard to believe that market makers would drop their bids and hard, if they felt that they could get away with it. This would definitely translate to harm for other shareholders as compared to more modest selling over as longer period of time. And, as many people have repeatedly pointed out, 401k’s are not really meant as vehicles to trade constantly. Still, it does seem to be a bit unfair to change the rules so abruptly. Even if it was true that the American Airline employees single handedly caused the T Rowe Price junk bond fund to lose value, that is arguably part of the game. If the newsletter suddenly advised its subscribers to buy up another T. Rowe Price mutual fund then the company, if not necessarily the shareholders, would benefit from that. Basically, its part of the game, and while highlighting a flaw in the system, that doesn’t change the fact that this is how the system is structured.
But even after saying all of that, it is hard not to understand where the company is coming from. First of all, 401k’s really are not designed for frequent trading. That feature is offered so that people have the option if wanted for those few times where it might be warranted. Additionally, forced selling by the money managers is part of the system, no doubt, but it is hard to argue that in illiquid assets mass selling can harm all of the shareholders (at least a little). So while the story is definitely interesting, as I have never heard of a company causing so much disruption before, ultimately T. Rowe Price is probably correct to put a stop to it.