Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Mutual funds supporting their parents

Nearly three years ago, Ajay Shah sent out an email to a few of us about how the regulatory framework of a “first world country” would deal with possible conflicts of interest between a mutual fund and its parent company. At that time, it was too early in the global financial crisis for me to give the flippant answer that there are no first world countries any more – we are all third world countries.

The example that I gave then was that of UBS allegedly stuffing its own shares into its mutual fund and into the portfolios of wealth management clients and then voting them to win a proxy war against Martin Ebner way back in 1994. Holders of class N shares voting in favour of the UBS share unification proposal in that meeting were effectively voting to destroy the value of their own shares as Loderer and Zgraggen explained in an interesting paper (“When Shareholders Choose Not to Maximize Value: The Union Bank of Switzerland’s 1994 Proxy Fight”, Journal of Applied Corporate Finance, Fall 1999). Ideally therefore, portfolio investors should have sold all their class N shares ahead of the meeting.

But now there is an academic paper showing that Spanish mutual funds buy shares in their parent banks to prop up the share price after a significant fall (Golezyand and Marinz, “Price Support in the Stock Market”, SSRN, June 2010). The paper finds compelling evidence for such price support with careful econometrics that rules out alternative explanations like portfolio rebalancing into the banking sector, contrarian trading, timing skills or information-driven trading.

The authors point out that “Strictly speaking, price support activities by mutual funds are illegal, as the trades are not necessarily placed in the interest of the fund investors.” However they also believe that Spain is a country in which such crimes are not closely monitored and are not severely prosecuted.

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One response to “Mutual funds supporting their parents

  1. vv November 13, 2010 at 11:30 am

    Sir a classic example of this may be Reliance ADAG group and several other industrial conglomerates with financial arms.
    This is especially important because IMHO it is nothing but circular trading.
    Also, in the context of RBI looking to grant new banking licenses it would be advisable to filter out groups that indulge in circular trading.
    Circular trading is bad enough , circular banking with other people’s life savings could be devastating .
    By the way your blog posts are awesomely insightful thanks.

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