To make a quick buck, some hedge funds give the industry a black eye by quickly profiting from information leaking out of a giant mutual fund. The mutual fund, for example, may be accumulating a large position in XYZ stock.
Let's say XYZ stock is offered at $20. The hedge fund, hearing about a mutual fund's plan, immediately buys 100,000 shares in XYZ by taking all the stock offered in a price range of $20 to $20 1/4 a share.
As the market has moved up because of the hedge fund's trading activity, the hedge fund then turns around and sells the stock back at a premium. The hedge fund knows there is a willing buyer: the giant mutual fund.
Some traders derisively call funds that play this game "bottom feeders." They describe the money they make as "fast money." In the example, the mutual fund paid far more than it should have because of the hedge fund's lighting-fast strategy. Substantial damage occurs, say some traders, because XYZ stock was "on the move" for all market participants. The first investor obtains much fewer shares than needed. And it might take weeks for the stocks to settle down.
The problem is not isolated to just the buyside, however. "There are adversarial hedge fund managers who tick off the sell-side traders," said Todd Harrison, head trader at Cramer, Berkowitz & Co., a New York-based hedge fund with $350 million in assets under management.
Harrison cites another example of questionable activity. A hedge fund, having heard an analyst is about to upgrade XYZ stock, or some other potentially market-moving information, calls a dealer. He does not tell the dealer what he has heard.
"He will take them [the dealer] for 100,000 or 200,000 shares of the stock making, say $500,000, before the upgrade," Harrison said. "The sell-side trader is hung out to dry."
