SANTA MONICA, Calif. -- At least three mutual fund companies have banned Wilshire Asset Management from using their fund families.
Officials at Strong Funds, Fremont Investment Advisers and a third firm that requested ano-nymity contend Wilshire Asset had been abusing the free exchange privileges they offer investors.
They say Wilshire Asset had been moving between their companies' money market funds and aggressive midcapitalization stock funds in what appeared to be a market-timing strategy.
Strong also has banned Summit Advisors Inc., Santa Monica, Calif., owned by Wilshire Chairman and CEO Dennis Tito, for allegedly pursuing the same strategy.
Wilshire Asset is owned by Wilshire Associates Inc., Santa Monica, one of the nation's largest pension fund consulting firms.
Said Stephen L. Nesbitt, senior vice president at Wilshire Associates: "We have always been very responsible in our trading. . . . The last thing we want to do is cause portfolio managers to buy or sell stocks because of us."
Mr. Nesbitt said Wilshire doesn't want to "surprise them (mutual funds) with our strategy, and we prearrange it ahead of time with the fund family."
But officials of the three companies that banned Wilshire said they had no prearrangement.
Mr. Tito was out of the country and unavailable for comment, Mr. Nesbitt said.
Wilshire Asset's and Summit's trading practices were brought to Pensions & Investments' attention by an official at the mutual fund company that requested its name not be used.
Mr. Nesbitt said Wilshire has complied with requests to leave "many" mutual fund companies he would not name.
Strong, Menomonee Falls, Wis., stopped Wilshire Asset from trading actively in its fund family in 1996.
Fremont, San Francisco, did so last year; and the third company, in spring of this year.
In all three cases, Wilshire Asset had greatly exceeded the permissible number of "round trips" in and out of individual funds in each family. Round-trip limits are stated in a fund's prospectus.
Mr. Nesbitt said Wilshire Asset managers read the prospectuses of the funds in which they invest and "don't exceed the rules" on the number of free exchanges. When told of the Strong and Fremont cases, Mr. Nesbitt said Wilshire exceeded the permitted number of round trips with the concurrence of the marketers who sold the funds to Wilshire.
He called the round-trip issue a "gray area" and said Wilshire relies on fund companies to police and enforce their own rules.
"It is within the rights of the mutual fund company not to accept our trades. If they say we can't perform this kind of strategy in their fund families, we leave with no arguments," he said.
Wilshire Asset uses mutual funds to take positions in different stock styles, such as small-cap, growth and value, rather than classic market timing, Mr. Nesbitt said. The strategy also is known as factor exposure. "We don't believe in market timing, but I think to some mutual fund companies we invest in, our trading style might seem like market timing," he said.
Mr. Nesbitt said the hedge-fund-like strategy uses a computer-generated model that actively trades in small-cap mutual funds.
Portfolio managers select stock funds with a relatively high cash position, he said. Trades then are adjusted so they never exceed 10% of the cash position of any mutual fund used, he said.
Overall, Wilshire manages $160 million in the strategy, which "is very trivial in the context of a $3 trillion mutual fund market," Mr. Nesbitt said.
At Fremont, Wilshire Asset opened a handful of accounts in December 1996, said Richard Thomas, senior vice president.
Some were opened in the name of broker/dealers, some for corporations and some for individuals.
Wilshire traded actively between a money market fund and a microcap stock fund, where the average capitalization is less than $100 million, Mr. Thomas said. Such active trading made it impossible for the portfolio manager to get the money invested before it was pulled out again, he said.
The amount of money housed in the accounts was in the millions.
"That's part of the strategy, to keep the dollar figures fairly low," said Mr. Thomas. "If someone wires in $10 million, I'm all over it. If it's $150,000 or $300,000, it might not be noticed."
A typical Wilshire-managed account made 20 round trips during a five- to six-month period, Mr. Thomas said. Each Fremont fund has a limit of six round trips per year, although Mr. Thomas said that limit may be extended, by prearrangement.
But Fremont and Wilshire Asset had no such arrangement, he said.
"We wouldn't let them in if they asked us ahead of time for permission to use our funds, especially our very small microcap fund, for this kind of active trading. At the time Wilshire invested with us, the fund had less than $100 million and, as the most expensive stock style to manage and given the amounts they were moving in and out, this kind of trading definitely had an effect on performance," Mr. Thomas said.
When Fremont officials discovered the problem, they tried to work out an arrangement that would accommodate Wilshire's style. "We like to have close working relationships with our clients, especially institutional clients, and Wilshire would not be flexible about which funds they would use or the number of trades. . . . So we blocked their exchange privileges into funds with only a few hundred million in them and they left," said Mr. Thomas.
At Strong, Donald Tyler, vice president of Strong Intermediary Services, said: "We were hit with very aggressive market timing by Wilshire and an affiliate, Summit Advisors, in 1996, and it wreaked havoc in our funds . . . It wasn't a very favorable experience for us."
Mr. Tyler noted with "most advisers who use market timing strategies, if you tell them to cease, they do. But Wilshire was completely determined to get around our system."
In June 1996, Strong first investigated unusually high trading levels in four accounts opened at the same time earlier in the year. Two turned out to be Wilshire's; two were Summit's, through Marlborough Equity Partners. The accounts actively traded almost daily between equity funds and money market accounts. Wilshire had about $600,000 invested and Summit, just less than $1 million, said Matthew Fleming, client services manager.
Wilshire and Summit Advisors were asked to leave the funds, which they did in July and August of 1996, Mr. Tyler said.
By September, however, Strong officials noticed a similar trading pattern in two other Summit accounts.
Mr. Fleming said when Strong approached Summit about the new accounts, a company official said, "Oh, you noticed us." Those accounts were closed at Strong's request.
"It's conceivable that we still have some Wilshire and Summit accounts that are below our radar screens in terms of size and activity level," Mr. Fleming said.
Strong has amended the wording of its prospectuses to make it easier to police market timers. The new method will allow Strong to freeze any investor it suspects of market timing.
THE THIRD COMPANY
An official at the third company said he was told by Joseph E. Pastore, a senior associate at Wilshire Asset Management, that Wilshire had practiced the strategy -- part of a larger arbitrage strategy -- at many mutual fund families.
"He said Wilshire had been doing this for six years and wondered why we were upset about it. He claimed he tries to work with managers and that he was targeting funds with enough cash to cover liquidity, but none of our funds can tolerate so much churning," the fund company official said.
"We work very hard to avoid being a problem for anyone. That's Joe's (Mr. Pastore's) job. Our parameters are such that we think we are well below their cash limits, usually well under 10% of the cash position," said Tom Stevens, Wilshire Asset's chief investment officer. Mr. Stevens would not permit his staff to talk to the press.
This company has a limit of four round trips per year. Yet Wilshire made 17 round trips -- between a money market and an aggressive midcap growth fund -- within a month after opening $1 million account on behalf of a corporate trust client last spring.
"We spent hours untangling what they'd done and when we figured it out, we kicked them out," said another official at the mutual fund company.
Wilshire had opened at least five other accounts in the company's other mutual fund family for bank trust clients. Although the fund family has a limit of three round trips per year, Wilshire made at least 12 round-trip trades in about eight weeks in most of the accounts. Both large- and small-cap funds were used for trading.
LURED BY MARKETERS?
But Wilshire Associates' Mr. Nesbitt said there could be more to the story than mutual fund company officials are admitting.
"Our portfolio managers . . . said there are times we are actually enticed into a family of funds by the marketing people, who promise that this kind of style can be accommodated. But when it comes down to dealing with the actual number of trades, it turns out that the operations people at the mutual fund companies have a hard time with the strategy . . .," he said.
"Market timers are the scapegoat when performance is suffering, and they are perhaps lumping us in with the market timers."
Still, Wilshire Asset saves a lot of money by using mutual funds with no transaction costs, rather than buying small-cap stocks directly, said Wayne G. Wagner, chairman of the Plexus Group Inc., Los Angeles. The average total implementation cost of trading smaller-cap stocks is 4.49% per trade, according to research from Plexus, which tracks trading costs.
"They seem to be using mutual funds so they don't have to pay transaction costs, which they'd have to do if they bought the securities and did the trades themselves," said Marc Spungin, president of Prairie Investment Man- agement LLC, Chicago, a hedge fund manager of managers.