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:
- Consistent with the fact that small and illiquid stocks are subject to higher price pressure and are easier to manipulate, fund families choose to buy small stocks to pump the portfolios of their star funds.
- It is more likely that managers of large funds in small families help pump their star funds. And it is very likely that managers engaging in the family-level portfolio pumping are the same managers of the star funds in the family.
- Fund managers inflate their NAVs at quarter-ends (including year-end) and NAVs reverse on the following trading day. The average daily return of funds at the end of the quarter is 0.48%, and -0.46% at the beginning of the quarter.
- The average daily return of funds at the end of the year is 0.07%, and -1.02% at the beginning of the year.
- There is no NAV change at the close of months not ending a quarter.
- Focusing only on star funds in fund families, NAV inflation exists at quarter-ends (March, June and September). The average daily return at quarter-ends is 1.01%, and the average daily return in the following days is -0.61%.
- The average daily return of star funds at the end of years is -0.43%, and -2.57% at the beginning of years.
- There’s a spillover effect, as fund managers are compensated more with future inflows when they pump the portfolio of star funds in the family.
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.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.