Nicholas Pratt talks to Alfi’s Geoff Radcliffe about the growing use of swing pricing in Europe and beyond.
Luxembourg is home to the swingers, apparently. A survey conducted in December by Alfi, the Luxembourg funds industry association, showed that swing pricing is now employed by two out of three asset managers.
What is swing pricing, you ask? It’s an adjustment to a fund’s net asset value (Nav) designed to protect shareholders from other investors making redemptions or purchases.
Alfi’s finding compares with just 13 out of 19 respondents when it last conducted a survey of swing pricing back in 2011.
One reason that swing pricing has become more popular with fund managers is the fact that so many more domiciles are allowing it, says Alfi board member Geoff Radcliffe. The list currently includes Australia, the Cayman Islands, Finland, France, Hong Kong, Ireland, Jersey, Norway, Switzerland and the UK.
This list will soon include the US, following the Securities and Exchange Commission’s inclusion of swing pricing as part of a wide-ranging review of open-ended funds and their associated liquidity risks. More specifically, the SEC is exploring the use of swing pricing as a means to ensure loyal long-term investors are not left out of pocket by more active traders and also as a liquidity management tool that can be harnessed during periods of large redemptions.
“As more markets allow swing pricing, its popularity will only continue,” says Radcliffe. “It offers a simple and practical way of protecting shareholders against dilution caused by investors dealing within the single Nav structure and constraints caused by large dealing volumes and time-sensitive fund valuation processes.”
Closer inspection of the Alfi survey shows that there is a big divergence in the methodology used by various firms. It is a divergence that goes beyond the two distinct forms of swing pricing – ‘full’ whereby Nav is adjusted daily, regardless of the size of shareholder dealing, and ‘partial’ whereby swing pricing is applied only when net capital activity is greater than a pre-determined threshold.
For example, there are differences in the components used to calculate swing factors, the fund types to which swing pricing is applied, and also the extent to which funds disclose their use of swing pricing and the methodology employed.
This divergence begs the question of whether there should be a standard means of calculation or at least a standard level of disclosure. “The idea of one standard calculation methodology seems logical, however a one-size-fits-all approach seldom does fit all and a principles-based approach has so far proven successful for different business models and for different systems and operating models,” says Radcliffe.
The methodology applied by a particular fund manager will depend on a number of factors, including distribution base, timing of dealing cut-offs and valuation points, fund accounting and price dissemination processes and systems, as well as trading processes and the way investor dealing is processed, says Radcliffe.
Alfi produced ‘Swing Pricing Guidelines’ in 2015, which details a number of methodologies used by fund managers in Luxembourg that are “tried and tested”, says Radcliffe. “Most fund managers provide substantial literature about swing pricing, why it is applied, what it does, and explaining how it works.”
It is also important to remember that the protection achieved by price swinging is for the long-term investors in the fund and not for the benefit of the fund manager, says Radcliffe. “One thing that sometimes comes up is that investors love swing pricing while they are in the fund, and appreciate the protection it gives them, but may not always be quite so keen when subscribing or redeeming.”
DISCLOSURE AND NON-DISCLOSURE
Radcliffe says the trend towards greater transparency is reflected in this year’s survey results, where almost half of respondents choose to disclose swing pricing information upon client request. Yet a similar number choose not to disclose these details.
The problem is that too much transparency could be counter-productive and managers want to protect sensitive information that could be manipulated by counter-dilution methods, says Radcliffe. An example of this is the threshold of a partial swinging fund, which if known could cause investors to invest or divest via several small deals in an attempt to game the system.
Similarly, by disclosing exact details of the components of a swing factor, it could reveal proprietary information such as a portfolio manager’s trading patterns or broker arrangements, thereby allowing investors to build up a pattern of trading strategies and processes that could be used unfavourably against the fund, says Radcliffe.
“There should be sufficient disclosure on methodology in the fund prospectus but also the flexibility to both evolve practices and to react swiftly to changing market, tax or regulatory conditions.”
Away from Europe, Radcliffe has viewed the developments in the US market with interest. The consultation period for the SEC’s liquidity management review ended on January 13 and the investment management market is now waiting for the final proposals and a timetable for adoption.
However, first a number of operational issues will have to be resolved, says Radcliffe. “The first challenge in the US is that there are operational and infrastructure support differences that prevent replicating the approach taken in many other countries, as trade flows are generally not available until early in the morning on T+1.”
This hindrance has been highlighted by other bodies in the US, including the Securities Industry and Financial Markets Association (Sifma), which represents asset managers as well as brokers and banks. Sifma accepts that swing pricing can be a useful tool for US mutual funds, although it asks that only partial and not full swing pricing be allowed, but says its implementation will require “substantial changes to the current operational processes”. In particular, the US market will have to look at the availability of fund flow information that forms the basis for Nav calculations.
The greatest challenge for managers in both the US and Europe may well still remain, though. And that is explaining the minutiae and mechanics of swing pricing to both their own senior management and their investors, and convincing the latter group that these daily adjustments to the fund’s valuation are actually for their benefit.
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