How Widespread is Late Trading in Mutual Funds?

This paper uses daily fund flow data to examine the extent of late trading in the U.S. mutual fund industry. Trading decisions that are required by law to have been made before 4 PM Eastern Time are correlated with market movements from 4 to 9 PM that evening. The cross- sectional variation in this correlation is consistent with late trading being its primary cause and inconsistent with alternative explanations. For example, apparent late trading ceases in September 2003 after the announcement of the investigation into mutual fund trading practices, it is three times greater in fund families that have been cited by regulators for allowing late trading, and it is greater in funds and asset classes that are also receiving heavy stale price arbitrage flows. In my sample, which includes 75 percent of non-specialized equity mutual funds and 48 percent of assets, late trading led to average annual shareholder dilution from 1998 to 2003 of 3.8 and 0.9 basis points in international and U.S. equity funds, respectively. If these dilution rates prevailed industry wide, they would imply shareholder losses of about $400 million per year. Furthermore, there is statistically significant evidence of late trading in the funds of 39 of 66 fund families.