November 12, 2008
Swing Pricing Alone May Not Be Optimal Solution forUCITS Performance Dilution, Says New Whitepaper
“Best practices” still evolving as new solutions emerge.
(LUXEMBOURG) ReFlow today released a whitepaper recommending that UCITS fund managers take a closer look at swing pricing and consider combining it with other anti-dilution measures.
ReFlow, a global provider of performance-enhancement tools for investment funds, released the paper in concert with the launch of its European operation.
Titled, “Expanding the Anti-Dilution Toolkit,” the 24-page paper focuses on efforts to counter the negative impacts of shareholder flow on fund performance, an issue now in the spotlight due to both market and regulatory trends. The paper also presents ReFlow’s liquidity solution, which has been in use by U.S. mutual funds since 2003 and is now being introduced in Europe.
With the recent turbulence in global markets, the Luxembourg fund industry has been hit by a sharp upswing in net outflows. In contrast to the more than €170 billion in total net inflows received in 2006, Luxembourg funds saw total net outflows of €80 billion in the first six months of 2008 alone.
High net outflows are problematic for fund managers, who may lack sufficient cash to meet shareholder redemptions and find themselves forced to liquidate securities they would prefer to keep. “When this happens, managers not only lose some control over portfolio strategies, they also incur transaction costs that dilute performance, hurting shareholders as well,” commented Paul Schaeffer, President of ReFlow. He emphasized that those cost impacts are due not only to direct dealing costs, including commissions, spreads, fees/duties, global custody, clearing, and currency conversion costs, but also to the hidden costs of delay and market impact, which are estimated to be two to three times greater than direct costs.
Swing pricing is a complex mechanism for passing on flow-induced dealing costs by adjusting funds’ daily Net Asset Value (NAV). By adjusting NAV up or down in response to net inflows or outflows, swing pricing penalizes some shareholders buying or selling that day while benefiting others; it also affects fund performance and operations. Swing pricing is the most widely discussed anti-dilution measure, but has not been widely adopted, states the whitepaper.
“Although swing pricing has been proposed as the current standard for countering dilution, at industry conferences fund managers have talked mainly of their struggles to deal with the complexities of swing pricing and come up with a workable solution,” said Simon Barnes, newly appointed head of ReFlow’s European operation.
The ReFlow whitepaper assesses the pros and cons of swing pricing, partial swinging, and other available anti-dilution measures, including lines of credit. It also introduces ReFlow’s own anti-dilution approach, which the firm is now making available to UCITS.
ReFlow’s solution provides funds that are experiencing net outflows with liquidity on demand, enabling them to completely avoid the costs and effort of flow-induced dealing. In essence, ReFlow becomes a short-term shareholder in exchange for providing the capital that funds need to meet redemptions.
The paper presents ReFlow’s solution as a complement to swing pricing, as well as a possible alternative. “Funds can use our approach to avoid all costs of flow-induced dealing, including the hidden costs of market impact and delay, which are major cost factors not passed on through swing pricing” explained Barnes. He noted that ReFlow also enhances partial swing pricing, which is triggered when net capital activity reaches a pre-set threshold, by helping funds reduce the number of days partial swing is triggered.
The ReFlow solution also offers advantages over swing pricing when considered as an alternative, said Barnes, in that ReFlow:
- Eliminates costs rather than allocating them.
- Is an automated, everyday solution easy to implement and use.
- Addresses hidden dealing costs, including market impact and delay.
- Benefits all shareholders by enhancing performance.
- Helps funds improve overall performance rankings.
- Has little or no impact on daily accounting procedures.
“Our hope is that this whitepaper will help to advance the discussion and the evolution of anti-dilution practices for UCIs,” said Barnes, noting that the whitepaper is the first in what is planned to be an ongoing series of ReFlow analyses and research products.
ReFlow’s liquidity solution has been authorized for use in the U.S. by 161 individual funds within 16 fund complexes with a total of more than $365 billion in assets. Based in San Francisco, California, the firm has since 2003 offered U.S. mutual funds a comprehensive toolkit for reducing the costs and risks associated with shareholder flow. Its tools are designed to preserve the performance fund managers have earned while freeing them to implement portfolio strategies unimpeded by shareholder activities.
Copies of the whitepaper and more information on ReFlow can be obtained by visiting www.reflow.lu or contacting Simon Barnes - Director of European Sales & Marketing, +352 26683 – 355 / SBarnes@ReFlow.lu.
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