What Is Portfolio Pumping?

Portfolio pumping, also known as "painting the tape," is the practice of artificially inflating the performance of an investment portfolio. It is typically done by purchasing large amounts of shares in existing positions, shortly before the end of the reporting period.

This practice is especially common among investment funds which hold positions in relatively illiquid securities, because the prices of such securities can be more easily manipulated. Securities regulators, such as the Securities and Exchange Commission (SEC), seek to detect and sanction this behavior by monitoring suspicious transactions.

Key Takeaways

  • Portfolio pumping is the practice of artificially inflating portfolio performance.
  • It is done by purchasing shares in existing positions shortly before reporting portfolio performance.
  • Public awareness of portfolio pumping has been increased by a series of influential academic articles, and the practice is now more tightly monitored by securities regulators.

Understanding Portfolio Pumping

Portfolio pumping is harmful for investors because it provides an inaccurate impression of portfolio performance. This in turn can lead investment managers to collect incentive fees which are not justified by their actual performance.

To illustrate, consider an investment fund which owns shares of XYZ Corporation, purchased at $10 per share. If those shares are valued at $7 shortly prior to the investment fund's reporting period, an unscrupulous manager might inflate their value by placing a large volume of new orders for the stock at an inflated bid price, such as $14 per share. In the short term, this new demand would boost the fund's stated performance, because the position in XYZ would now be valued at $14 per share rather than $7. In the days following the manipulation, however, the shares would likely revert to their $7 value.

Real World Example of Portfolio Pumping

Portfolio pumping began garnering widespread attention following the publication of an article in 2002, entitled "Leaning for the Tape: Evidence of Gaming Behavior in Equity Mutual Funds." This article, which was published in The Journal of Finance, provided clear evidence that portfolio pumping is a widespread phenomenon.

Following this research, the SEC and other regulators increased their oversight of portfolio pumping. However, there is reason to believe that the phenomenon continues to this day. In 2017, a researcher from the University of Rochester published a study—entitled "Portfolio Pumping in Mutual Fund Families"—in which he outlined how some fund managers have continued to use portfolio pumping strategies by exploiting legal loopholes in the regulatory regime.

Today, unethical investment managers can also use high-frequency trading (HFT) technologies to perpetrate portfolio pumping schemes. This practice has been the subject of special scrutiny by the SEC, who can punish transgressions by imposing civil fines and by banning actors from working within the securities industry.

Thankfully, the same advanced technologies that are used to manipulate investors can also be used to detect and deter manipulation. To that end, regulators use a variety of advanced analytics software to monitor suspicious trading patterns by using price and volume data from various markets.