Sent: 26-07-2011 09:52:43
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ASIC Tackles Window Dressing
ASIC's warning against end of fiancial year window dressing highlighted the prevalence of end of month price effects in the Australian stock market.
ASIC sent out a message to market participants at the end of June warning against window dressing. A penalty of up to $1 million may apply to market participants accepting orders having the effect of manipulating markets. Those placing orders may be subject to sanctions, including criminal penalties.
Window dressing is one form of market manipulation. It might occur under a range of circumstances. The most telling is when a relatively small order is placed to buy a stock close to the end of a trading period so as to leave the last trade artificially high and unrepresentative of market conditions.
Fund managers may be attracted to the practice when their fees are tied to end of month portfolio values. Individuals may also benefit from window dressing if loans, for example, are based on the value of a stock. Some contracts to transfer assets may also be based on a stock price at a point in time.
Window dressing, by its nature, would be most easily practised in illiquid markets for infrequently traded stocks. If it is a problem, one would expect Australia's resources sector, composed overwhelmingly of small companies, to be especially prone to its impact.
Between the beginning of 2000 and the end of 2010, the average daily movement in resource stocks within the ASX small ordinaries index was 0.08%, an annualized rate of increase of 22.1% with a standard deviation of 24.8%.
Over the same period, the average movement in this group of stocks during the last trading day of each month was 0.28%, an annualized rate of 103% with a standard deviation of 23.2%.
Whether or not window dressing or legitimate trading is the cause of this end of month pricing, at a minimum these statistics point to a clear seasonal phenomenon.
A market in BHP Billiton or any of the largest stocks, on the other hand, should be subject to highly liquid trading conditions throughout the day. Any unusual bid should be covered immediately, preventing any lingering market effect.
Over the same period of time from which the small resource statistics were drawn, the ASX 20 leaders index showed an annualized daily gain of 6.2% with a standard deviation of 18.2%. The average movement for the market leaders during the last trading day of the month was an annual rate of 13.0% with a standard deviation of 18.6%.
The end of month return among the 20 leaders was 2.0 times the average daily return. The end of month return among the small resources stocks was 3.5 times the average daily return.
Overall, we have a market with a strong tendency toward a positive end of month effect no matter what the size of the stocks or the general liquidity conditions. Against this background, the work of ASIC is that much harder.
Rising markets typically attract buyers. A trader seeing markets rise could easily be tempted to buy stock in response. Any end of month price effect is likely to be exaggerated by traders attracted by the market momentum. Also, money managers legitimately investing cash at the end of the month could put upward pressure on prices.
If we have a market in which a combination of legitimate trading and momentum effects lead to relatively high end of month prices, ASIC needs to be careful not to falsely characterize as unlawful behavior that should be regarded as acceptable.
Isolated instances of window dressing might be easier to chase down. In Australia, the end of month effect seems so culturally embedded that distinguishing motives in all but the most egregious instances appears especially tough.
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