Application of valuation principles – March and April 2020
As at 15 May 2020
- What is swing pricing?
Large transactions in and out of a fund may cause the fund manager to buy or sell the underlying investments of the fund thereby attracting trading costs which are borne by the investors in that fund. As a result, long-term unitholders in a fund can be adversely affected by other investors trading in and out of the fund. This effect is known as dilution.
Swing pricing is a mechanism to reduce dilution and potentially protect current investors. It aims to ensure that investors subscribing to or redeeming from a fund bear a portion of the trading costs i.e. the underlying spreads and transactions costs.
Swing pricing should not be confused with Fair Valuation Pricing (FVP). Swing pricing addresses the performance impact that can arise from the portfolio trading costs incurred by a single-priced fund, resulting from unitholder trading. These costs are made up of the spreads of the underlying assets, transaction or broker charges and taxes (for example the 0.5% Stamp Duty on the purchase of UK equities). Unless swing pricing is activated, these costs are borne by the fund, diluting its market value and impacting the current investors.
The key benefit of swing pricing is that it reduces dilution arising as a result of unitholder driven trading. We believe this outweighs the problems caused by short-term price volatility – and that swing pricing is in the best interests of our clients. In addition swing pricing is a standard industry mechanism used by all of our major peers.
Each fund has a swing factor, also known as a dilution adjustment, which is an estimate of the underlying dealing spreads, transaction charges, and taxes. The swing factors will vary for each fund depending on the costs the fund incurs when buying and selling underlying investments, as well as any dealing spreads.
- How does swing pricing work?
A fund’s price will be adjusted upwards or downwards in accordance with the daily unitholder flows. We will adjust the price upwards if net inflows exceed a pre-determined threshold of the fund’s value. The price will be adjusted downwards if net outflows exceed the threshold.
If net dealing does not exceed the threshold, swing pricing may not be activated. In this instance, the published price will reflect the mid-market or last-traded price of the underlying securities. On a daily basis, the price of the fund is always reset to this default position, before any swing factor is applied.
The ‘swung’ price will be used for all deals carried out that day and will represent the official Net Asset Value (NAV) of the day. The adjustment will be applied mechanically whenever there are net flows greater than the threshold. The fund management company has the discretion to implement a dilution adjustment even if the threshold has not been exceeded if, in its opinion, it is in the interest of existing unitholders to do so.
- How is the swing factor calculated?
The swing factor is an estimate made up of a number of elements, including spreads, commissions and other transactional costs. Spreads will be based on a portfolio snapshot, and a weighted portfolio amount is then calculated. Commissions and other costs (e.g. transaction tax) will be based on a historic analysis of actual trades. These costs are computed and calculated as a percentage of the total settlement amount of the trades under review.
- How often are the swing factors calculated?
In a regular market environment, the swing factor is updated periodically - usually every quarter - by analysing the trading costs of the underlying investments held in each fund. Given the extraordinary nature of the current market environment, we have been updating the swing factors used to reflect the current market conditions. We are keeping these factors under review on an ongoing basis.
- How often is swing pricing implemented?
This varies across funds and depends on a number of factors, such as the level of trading activity for each fund and the size of the fund. For example, a small new fund with frequent inflows will see swing pricing implemented more frequently than a large fund with a stable unitholder base.
- Does swing pricing affect the performance of the fund?
From a performance measurement and reporting perspective, there is the potential for short-term price volatility. However, we believe that the benefits of swing pricing outweigh any disadvantages caused by short-term price volatility.
Swing adjustments are based on net flows and therefore not based on underlying market movements. This adds to the potential for benchmark-relative performance issues. FVP and the valuation point versus benchmark-close timing mismatch also impact this. Fixed income funds are more sensitive to volatility resulting from swing pricing.
- Does Schroders benefit from swing pricing?
No. Swing pricing does not benefit Schroders in any way. Swing pricing protects the existing or remaining investors in the fund, as any dilution adjustment is borne by the subscribing or redeeming investor, and is for the overall benefit of the fund. There are rigorous controls in place to ensure these measures are carried out fairly and in accordance with industry best practice.
- Will performance fees be applied before or after the swing adjustment?
The daily accrual of performance fees (if relevant) will be applied before the swing adjustment, as the purpose of the swing adjustment is to protect existing investors from capital activity and is not related to fund performance.
- What is Fair Valuation Pricing (FVP) and how is it determined?
In calculating NAV, if any of our standard valuation principles do not seem accurate for the purpose of determining the value of the fund’s assets, FVP may be applied. The fund management company will allow for the NAV to be adjusted to reflect more accurately the fair value of the fund's investments in good faith and in accordance with generally accepted valuation principles and procedures.