Controlling Your Investment: Steps You Can Take to Lower the Impact of Front-Running in Mutual Funds
Front-running of mutual funds is a chronic problem that may result in huge losses for investors. Recently, the Association of Mutual Funds in India introduced guidelines to contain front-running and fraudulent transactions. This came after the Securities and Exchange Board of India asked for stronger laws after allegations of front-running against Quant Mutual Fund. These regulations notwithstanding, investors remain victims of such abuses. It is, therefore, very important for any investment that the learning of how to protect your portfolio against the adverse consequences of a front-running scam takes center stage today.
Front-running is a type of market abuse wherein insiders, usually brokers or officials, trade on inside information on an impending order. Now let’s say some insider from some mutual fund company reveals information on an upcoming trade. Other people with this information can pre-position themselves in that market. While this inappropriately enriches the insider, it also injures the long-term mutual fund investors.
It is problematic to monitor closely for front-running, but there are a couple of things that an investor can do in order to limit its impact. Conclusively, experts believe a mixture of diversification with active monitoring and positioning investment strategies protects portfolios.
By diversifying across asset classes and sectors, investors can minimize the risk of concentrated positions that frontrunners look to exploit and, at the same time, make it much more difficult for them to pursue specific stocks. A wide variety of sectors and geographic regions can also help an investor minimize his or her exposure to volatility in any one market.
Apart from diversification, one must be vigilant about the market and investment portfolio. Being updated about the market at all times and revising the performance of different funds from time to time will help the investors to show abnormal trends or patterns that might raise suspicion about the fund indulging in front-running. Again, it is pertinent to select an appropriate fund house with good compliance and governance. Thus, better protection against the potential malpractices in the market is assured to the investor.
Another possible alternative to avoiding the risk of being front-run would be investing passively-once again, one can consider investment in index funds or in ETFs. Passive investment strategies track market indexes without trying to outperform their returns. Passive funds have a lower likelihood of being targeted by front-runners because the nature of investments is ‘long-term’ and stable in return.
An investor needs to go back and read between the lines of the response from the fund house and also the subsequent action by SEBI, in case a mutual fund is accused of front-running. In fact, vigilant investors, with some precaution, can save their portfolios from the negative consequences of front-running.
There’s a good reason to be concerned about front-running if you are a mutual fund investor. However, diversification of your investment, being well-informed about financial matters, and passive investment strategies will minimize risks associated with this unethical practice.
