Bob Pisani was on CNBC this morning chatting about whether or not the NYSE will open tomorrow. One of the biggest concerns on Wall Street is that tomorrow is month-end, a time when asset managers need to post their net asset value and spill the beans on how their portfolio is doing.
Why would this be such a concern? The prices last Friday weren’t good enough?
During the conversation on CNBC, Jim Cramer commented on the obvious, “So we can either open tomorrow and get fake numbers, or we can open on Thursday and get real numbers?” Jim’s comment suggested that money managers engage in price manipulation at month-end.
Aren’t money managers perfect angels?
How could this be? Asset managers are perfect angels and would never attempt to manipulate prices to mislead investors…
Turns out there is a lot of evidence that money managers manipulate month-end or year-end prices to mislead investors.
We provide evidence suggesting that some hedge funds manipulate stock prices on critical reporting dates. Stocks in the top quartile of hedge fund holdings exhibit abnormal returns of 0.30% on the last day of the quarter and a reversal of 0.25% on the following day. A significant part of the return is earned during the last minutes of trading. Analysis of intraday volume and order imbalance provides further evidence consistent with manipulation. These patterns are stronger for funds that have higher incentives to improve their ranking relative to their peers.
Prices on the last few days of the month drift upwards; these same stocks fall on the first few days of the next month.
For funds with greater incentives and greater opportunities to inflate returns, we find that (i) returns during December are significantly higher than those during the rest of the year even after controlling for risk in both time-series and the cross-section; (ii) this December spike is greater than that for funds with lower incentives and opportunities to inflate returns. These results suggest that hedge funds manage their returns upwards in an opportunistic fashion in order to earn higher fees. Finally, we provide strong evidence that funds inflate December returns by under-reporting returns earlier in the year but only weak evidence that funds borrow from January returns in the following year.
Incentive fees are normally determined as of December 31, which means managers have a huge incentive to get a high year end mark. As the chart above shows, December is clearly different than your typical month.