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Fair Value Pricing Solution To Market Timers

- Alan Lavine and Gail Liberman

If you have invested in international stock funds over the past few years, your fund's return may not be as high as it should have been.

One reason: Market timers moved in an out of international funds to take advantage of stock price differences in the United States and overseas markets. International mutual funds calculate the share price of the fund, also called the "net asset value," at 4 p.m. But prices are based, for example, on prices in Asia, where the market closes 10 hours earlier. So a market timer with information about the Asian stock market could invest in an international stock fund right before the 4 p.m. United States deadline. The next day, the market timer would sell the fund shares for a profit when the market rises, based on the prior day's activity.

Recent research by Eric Zitzewitz, a Stanford University finance professor, found that market timing trading can cost investors 1 to 2 percentage points a year in a funds return.

Many mutual funds use a system called "fair value pricing," which makes price adjustments due to time zone differences in international markets. Fair value pricing in combination with limits on fund trades per year and exit fees keeps market timers out of funds.

But which funds are doing fair value pricing?

No one knows for sure. Spokespeople for Morningstar Inc., Chicago, and Lipper Inc., New York, two mutual fund data services, say they do not have official lists of funds that do and do not use fair value pricing. Many funds, though, are using fair value pricing, says Greg Wolper, analyst with Morningstar. "A list would be difficult to come by," he says. "But they may use different methods. Or they may use fair value pricing a limited number of times. It is difficult to determine."

The experts say the major fund groups all use fair value pricing. Those groups include Fidelity, Vanguard, T. Rowe Price and others. Small fund groups that use fair value pricing include Oakmark and Matthews.

So what should investors do? Call your fund group and ask if it uses fair value pricing. If not, find out when it may start using the system. If the fund group says it is not going to use fair value pricing, consider investing in another fund that does.

There is lot of pressure on the mutual fund industry to adopt fair value pricing by investors, the Securities and Exchange Commission and the media. So it is likely things will change for the better.

Beware, however. There are different methods of fair value pricing, so this system can be very subjective.


Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).

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