Mutual funds may be able to charge their investors who rush to cash out during periods of market stress under a rule being considered by the U.S. Securities and Exchange Commission.
Officials at the regulator think the change could curb the impulse to stampede out of mutual funds when asset prices are at risk of tanking, according to two people familiar with the matter who asked to not be named. The measure, which is part of a broader rule proposal scheduled for a Sept. 22 vote, could help funds cope with shocks such as a central bank’s move to hike interest rates that could prompt widespread investor withdrawals.
The Federal Reserve as well as other regulators have voiced concerns in recent months that mutual funds that have loaded up on less-liquid assets could struggle to sell holdings during a market rout, making it difficult to pay investors who want their money back. Last year, SEC Chair Mary Jo White announced plans to propose new rules to address worries that existing safeguards weren’t designed for funds that are increasingly investing in securities such as junk bonds and bank loans, and using derivatives to boost returns.
“This is trying to impose some countervailing pressure on redemptions during periods of instability,” said Robert Plaze, a partner at Stroock & Stroock & Lavan who was previously a senior regulator of mutual funds at the SEC.
Under current law, investors buy and sell shares at the fund’s closing price, known as net asset value. That reflects the value of the fund’s holdings and the total number of shares issued.
The SEC’s staff is now recommending that funds be allowed to pass on some of the trading costs they incur to meet redemptions to investors who exit. The concept, which is known as swing pricing, would allow funds to adjust the price that investors receive when they sell shares back to the fund. In effect, those investors would receive a price that is slightly lower than the fund’s closing price.
“It would be a pretty big change for the end investors to accept that the cash-out is not at the price they see,” said Sean Tuffy, the head of regulatory intelligence at Brown Brothers Harriman & Co.
The use of swing pricing would be voluntary under the SEC staff’s current plan, which could trigger questions about whether the agency’s action is aggressive enough to prevent runs on funds and protect investors who stay put.
The concept also could be seen as unfair or too complex to explain to retail investors, while also introducing more volatility into the price of mutual fund shares. Unlike redemption fees, which are imposed on investors who trade frequently, swing pricing could hit a long-term investor who sells on a day when lots of cash leaves the fund. The fees also could hit investors who buy shares on days when a lot of cash flows into a fund, which also requires trading, Tuffy said.
The approach could change as commissioners debate the details over the next couple of weeks, according to the people.
The SEC’s proposal would require that mutual funds have formal liquidity-management plans that must be approved by their boards of directors, the people said. It’s unclear whether the agency would set an industrywide threshold that triggers swing pricing, such as when withdrawals reach a certain percentage of fund assets, or allow fund managers or their boards to determine when the haircut applies.
The SEC has been forced in recent years to grapple with mutual funds being vulnerable to runs that can harm other investors. In 2008, the U.S. government had to temporarily guarantee the assets of money-market mutual funds after panicked shareholders yanked $310 billion from money funds in a single week. The SEC responded with rules last year that allow money funds to temporarily suspend withdrawals or impose fees when a fund can’t meet redemptions.
BlackRock Inc., the world’s largest money manager, has supported swing pricing for mutual funds in its discussions with regulators and commonly uses it for European funds, according to the people. BlackRock has said that swing pricing has increased shareholder returns by as much as 2.5 percentage points by shifting trading costs to exiting investors in cases in which it was used. The firm has a committee that decides how much to charge investors for redemptions.
For example, BlackRock’s Asian Tiger Bond Fund generated a
7.11 percent return from July 2010 to June 2011. BlackRock adjusted the price for redeeming shareholders on 72 days during the period, according to a policy paper it published in December
2011. The fund’s return would have been 4.59 percent had it not changed the price that sellers received on those days, the company reported.
“If the SEC comes and says you can add this to your toolkit, I don’t think there will be a lot of handwringing because those who don’t want to do it, won’t use it,” Tuffy said.