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updated 1/29/2004 2:31:53 PM ET 2004-01-29T19:31:53

Investors who bought variable annuities lost more money to market timers than investors who put their money in tainted mutual funds, according to new data from Lipper, the U.S. fund-tracker.

The analysis shows that such rapid trading was more widespread in variable annuity funds than in mutual funds.

Don Cassidy, a Lipper analyst, said variable annuity fund investors got "slaughtered by the people who were market timing in their funds because their expenses were so much higher".

Variable annuities — which are life insurance products marketed to elderly people — would appear to be an unlikely haven for short-term traders.

But they do offer the opportunity to invest in clones of international mutual funds and also provide tax-deferred investment privileges.

Data from Lipper indicate that improper trading was rampant in variable annuity funds.

Of 220 international equity annuity funds, nearly half had churn rates — levels of sales and redemptions — of more than 100 per cent in 2002, which represents a level almost impossible to achieve without short-term arbitrage.

A handful of variable annuity funds had churn rates that were higher than variable annuity funds specifically set up for frequent trading.

In comparison, Lipper data indicate that only about one in four international mutual funds had churn rates of more than 100 per cent in 2002.

U.S. regulators are now on the trail of hedge funds that were potentially rapidly trading in and out of variable annuity funds.

In order to do so, they would have had to find someone to pose as an individual and take a physical exam, according to a lawyer familiar with their investigation.

"Market timing" variable annuity funds is a fairly difficult venture.

Unlike mutual fund investors, people who buy variable annuities pay higher fees up front and typically lock their money up for a long period to defer paying taxes.

A hedge fund interested in getting out of an annuity would also have to pay an expensive surrender charge.

"It's a fairly expensive way of market timing but everyone became hungry after the market crashed. From what I've observed there were still some opportunities in the variable annuity world," said a person familiar with the investigation.

Analysts say "market timing" variable annuity funds is particularly egregious because people who buy such annuities expect their money to be locked up for a long time.

"You could make the argument that it was more harmful because everyone invested would expect their peers to be 'buy and hold' because they were sold as retirement products," said Bill Flaig, director of investments at Rydex Investments.

Copyright The Financial Times Ltd. All rights reserved.

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