Unraveling the Mysteries of Market-Timing

But because the Asian exchanges close hours before the NAV is calculated on U.S. funds, there's an opening for some pricing inefficiency. Maybe Sony (SNE Quote) announces some good news during the U.S. market day -- after the Asian exchanges have closed.

A market-timer (say, a hedge fund or even an executive at a mutual fund company, as has been alleged in the cases of Putnam and Strong funds) can simply buy shares in the U.S. Asia Stock Fund at the $9 NAV, and then sell the following day when the prices pop.

So the trader spends $10 million to buy 1.11 million fund shares at $9 each. The next day, Asian stocks rise and the fund's assets swell 10% to $99 million, giving it an NAV of $9.90. The trader sells at this new NAV, and pockets $989,000 in profit. (That's 1.11 million shares sold at $9.90, less the $10 million spent to purchase them.)

The investors who stay in the fund, though, see the fund's assets drop to $98 million -- leaving them with an NAV of only $9.80, rather than the $9.90 the trader cashed out at. So the market-timing trader gets a big gain -- at the expense of the long-term investor.

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