What is Portfolio Pumping
Portfolio pumping is the illegal act of bidding up the value of a fund's holdings at the end of a quarter to manipulate its performance. This gets done by placing a large number of orders on existing holdings, which drives up the value of the fund. Portfolio pumping is more common in funds that hold small and illiquid stocks, which are easier to manipulate.
For instance, if a hedge fund holds 80,000 shares of a company that has a small float and only trades an average of 2,000 shares a day, a buy order for an additional 10,000 shares can significantly increase the stock’s price. Portfolio pumping is also known as "marking the close” or “painting the tape.”
BREAKING DOWN Portfolio Pumping
Portfolio pumping can be highly destructive for investors in a fund because it represents a temporary gain in its value; the stocks in the portfolio typically revert to previous levels once the price manipulation is over. For example, suppose a fund has 1,000 shares of ABC purchased at $10 per share. If the shares are trading at $7 right before the manager's performance is measured, they have performed poorly. As a result, the manager may resort to portfolio pumping and place enough orders to bid the price up to $14, dramatically increasing the fund's performance. However, the shares are likely to fall back toward $7, leaving investors with a $7 stock that was made to look like a $14 stock. Misleading returns also can damage investor confidence, which may affect a fund’s ability to attract new investment capital.
Portfolio Pumping Prevention
The Securities and Exchange Commission (SEC) attempts to prevent portfolio pumping by imposing hefty fines for fund managers who engage in the activity. SEC regulation has resulted in several high-profile fund managers being ordered to pay a $75,000 civil penalty and getting banned from the securities industry for a period of time. The SEC uses a variety of analytics software to monitor suspicious trading patterns using price and volume data in multiple markets.
In recent years, the SEC has also cracked down on fund managers who use high-frequency trading for portfolio pumping purposes. An additional measure to prevent portfolio pumping could include fund managers having to disclose the exact date and time the portfolio’s holdings were purchased. A fund manager would be hesitant to buy additional shares of an underperforming portfolio holding at the end of a quarter if that information had to be disclosed to investors. (To learn how the SEC regulates the securities industry, see: Policing The Securities Market: An Overview Of The SEC.)