The SEC, as part of their initiative around the new liquidity rule, has given the green light for funds to implement Swing Pricing. For those not familiar with the Swing Pricing concept, basically it allows a fund to bump up or down their end of day NAV to help cover their increased transactional costs when market volatility causes higher than normal purchases or redemptions. It will be voluntary for a fund company if they want to implement Swing Pricing. Funds are prohibited from implementing it until November 19, 2018, in order to give those funds that do not have experience with Swing Pricing time to implement needed system changes. Swing Pricing is popular in Europe and those funds with a presence in Europe would perhaps have an advantage in being able to implement earlier than other funds, hence the delayed date.
The concept of Swing Pricing is great in the eyes of the fund’s portfolio manager. When flows in or out on a day are exceptionally large, the fund does incur increased transactional and other costs in either liquidating securities to meet cash requirements or having to find appropriate securities to invest the influx of cash. Swing pricing allows the portfolio manager to pass along those increased costs to just those shareholders that are trading that day. So this is good for the fund as these costs don’t have a negative effect on the fund’s performance and good for the remaining shareholders as they don’t have to subsidize the increased transactional costs due to those shareholders trading on the high volume day.
But Here is the Rub
Swing pricing works fine in Europe because order cutoff is generally mid-day rather than the 4 p.m. cutoff in the U.S., so intermediaries have time to submit orders prior to the fund striking its daily NAV. In the U.S., it’s a different story. The trillions of dollars in US retirement plans are heavily invested in mutual funds. Most retirement plan trades do not actually get transmitted to the fund until early the following day. It is not uncommon for 50 percent or more of a fund’s daily trading volume to come from retirement plans. As the vast majority of retirement plan recordkeepers have to wait for the daily NAV to be published before they start their “nightly cycle,” the earliest that most recordkeepers can place their trades would be after 7:30 p.m. Eastern time. Most end up trading later than that with many of the larger recordkeepers trading between 2 a.m. and 6 a.m. the following day. Even 7:30 p.m. is too late to be able judge what a fund’s flows will be for the day.
Due to the large amount of trading volume coming from retirement plans and our 4 p.m. cutoff time for trades, this will require funds to rely on estimates to determine a good portion of their daily flows. The SEC is OK with a fund using estimates. I might point out that the SEC only allows “partial” Swing Pricing is the U.S. This means that the fund can only implement a swung price on a day when the flows exceed a pre-determined threshold as set by the fund, which means you have to know your flows for the day to see if you will exceed your threshold limit before you can swing that day’s NAV. Due to the dependency on estimate, it seems logical that a fund may set the threshold fairly high to be sure and try to cover their costs on the really volatile days while avoiding the risks of many more estimations (and increased risk of making a bad estimate) that would be needed if they used a lower threshold.
If retirement plan recordkeepers could modify systems to run estimated flows based on prior day NAVs and submit that to the funds by 5 p.m. or so, then it would certainly give the funds a better estimate of their flows. But this would be burdening the retirement plan recordkeepers with increased costs in a business that already struggles with thin margins.
Will Swing Pricing Survive in the US?
I have not seen any numbers out of Europe on how many basis points a Swing Pricing policy adds to a fund’s performance, but I would think it would be negligible, especially if they only need to swing their prices a few times a year. Money market funds are not allowed to implement Swing Pricing and many other funds are not subject to volatile market movements so Swing Pricing would only apply to a subset of a fund’s product offerings.
So are mutual fund companies going to build advanced analytics systems to help them make accurate estimates of flows? Are retirement plan recordkeepers going to modify systems to provide better flow data to fund companies, so that some of those funds can get a slight bump in their performance? Right now, I would say the reward may not be worth the cost or the risk.
When November 19, 2018 arrives, Swing Pricing may just be Dead On Arrival.
L. Burton Keller was a principal founder of the company in 1985 and currently focuses on strategic initiatives for the company. Mr. Keller is a former member of the Bank, Trust and Retirement Advisory Committee of the Investment Company Institute. He has served on numerous committees and task force groups with the ICI over the last 17 years including Co-chair of the Dividend Distribution Task Force.