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Tuesday, December 09, 2003
MFS Again
OK, maybe I was a little hasty in opining that MFS was clean. According to this Boston Globe article, the SEC is ready to bring indictments regarding market timing in several of their funds. The funds involved were large domestic funds, not the usual international or junk bond funds used in market timing. They put the policy in a memorandum, which makes the investigation a lot easier. Reading between the lines, it looks like one of the Prudential brokers is trying to make a deal by turning in his confederates. Again, market timing is not illegal, but there is a problem if the prospectus says they do not allow it while it is in fact permitted for favored clients.

There was not much of a market timing opportunity in the MFS funds where the practice was allowed. International funds attract market timers because the lag between the fund's pricing time and the underlying market's close creates an arbitrage opportunity. Junk bond funds create arbitrage opportunities because they hold many securities with very little liquidity, so the prices used to value the portfolio are often stale (that means wrong today, although maybe right last month). The MFS funds were large domestic funds, mostly domestic equity. Market timers were apparently exploiting the differences between the fund's price (based on the prior day's pricing until 4:00 PM) and the price of the closest related index, such as the S&P 100 for Massachusetts Investors Trust or NASDAQ for MFS Emerging Growth Fund. If there was a big upward move in the index, the market timer could buy the fund and lock in the gain for the day, since the fund was sold at a price that did not include the day's results. This would be a small amount in isolation, but a guaranteed profit of 1% for one day's investment is pretty good money over the course of a year.

This is particularly unfortunate for MFS because they had just settled their previous SEC problem involving insider information on Treasury bonds.

The real problem for individual investors is that if the MFS funds track the indices so closely, why are they paying the steep fees to MFS for index performance? Why not buy a cheap index mutual fund or exchange-traded fund?
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