Annuities: The Other Variable in Abusive Fund Trading

There are a few important points and caveats to make regarding the chart. The screen unearths only red flags on abusive trading -- not smoking guns. Also, annual redemption figures aren't as granular as day-to-day trading data, which might more clearly reveal time-zone arbitrage or other improper trading activity.

Also, some industry officials and watchers said the data shouldn't be given too much importance. "Is it a 'sky is falling' situation? I don't think so," said Paul Huey-Burns, former assistant enforcement director of the SEC, who recently joined law firm Dechert LLP as a partner. "I don't want to minimize it, but we need to be careful that the anecdotal evidence that we're seeing doesn't cause a groundswell that undermines all the good that funds and annuities have done for people."

Nonetheless, "usually the best indicator of market-timing is watching the money coming in and going out," said the variable annuity official.

Of the 40 variable annuity funds on the list, 32 are focused on overseas investing -- including the Putnam VT International Equity fund, which the firm has acknowledged saw market timing in December 2002 and January. Of the remaining seven funds, four are offered by Rydex and ProFunds, two fund firms whose raison d'etre is allowing investors to market-time, so regulators have no truck with them -- and it is telling that their funds aimed at rapid-fire trading still don't top the list.

Among the other four, two funds are from Fred Alger, which has been a focus of the late-trading investigation by Spitzer's office, and one comes from Invesco, whose parent company may face impending securities fraud charges by Spitzer.

The last is the Van Eck Worldwide Insurance Hard Assets fund, a natural-resources fund from a small New York mutual and hedge fund firm whose Emerging Markets fund ranks at the top of the redemptions list -- the $4.66 billion in redemptions were more than 30 times greater than the fund's $151.1 million in net assets. Officials at Van Eck, a New York-based asset manager, didn't return calls for comment.

In total, the "red flag" funds on the chart housed $7.1 billion in assets at the end of 2002, and had $43.5 billion in redemptions during 2002. The $7.1 billion constitutes less than 1% of the $795.5 billion in assets under management in variable annuities in 2002 -- and it's highly unlikely that all the money in these funds would be "market timing" money. However, 80 other funds within variable annuities -- with combined assets of more than $20 billion -- had redemptions as a percentage of net assets in excess of 100%, according to Lipper. And three-quarters of those funds had redemptions as a percentage of sales within 20 basis points of an even 100%.

Unlike a recent screen TheStreet.com ran to unearth red flags at certain mutual funds, searching for potential improper trading in funds within variable annuity accounts isn't as simple as naming the specific funds. Why? It has partly to do with the nature of variable annuities.

Exploring the Variables

Simply put, variable annuities have more tentacles then the average mutual fund. Variable annuities are typically offered by insurance companies such as AIG(AIG Quote) and Dutch-based ING (ING Quote) -- although they are also sold through a variety of channels, including brokers such as J.P. Morgan(JPM Quote) and banks such as Wachovia(WB Quote).

The insurer or other annuity provider offers an insurance contract to the annuity holder, but the underlying investment options are often not the insurer's products. (Of course, the lines are getting blurred, as Vanguard, T. Rowe Price(TROW Quote) and other investment firms get into the variable annuity business and insurers increasingly offer in-house funds.)

So, for instance, noticing the three Janus(JNS Quote) Aspen offerings on the red flag list doesn't necessarily mean that Janus -- which has acknowledged having market-timing arrangements in its funds, confirming allegations first made by Spitzer -- had anything to do with the frequent trading activity in the Janus Aspen Worldwide Growth fund or the two share classes of Janus Aspen International Growth. Indeed, a Janus spokesperson said earlier this week that the firm's "12 discretionary arrangements" with market-timers didn't involve variable annuity accounts.