Swing pricing is a mechanism used by open-ended investment funds to protect existing investors from the cost of other investors' buying and selling. When more money enters or leaves a fund than usual, the manager must buy or sell portfolio assets, which incurs dealing costs. Under swing pricing, the fund's price per unit for that day is moved, or swung, by a small percentage in the direction that passes those costs on to the investors who are dealing. It is widely used by funds domiciled in Luxembourg, Ireland, the United Kingdom and other European centres.
The technique is one of several anti-dilution tools. Its closest alternative is the dilution levy, a separate charge added to or deducted from an individual investor's deal. Both address the same problem, but swing pricing works by changing the single price at which everyone deals on the day.
The problem it addresses
A fund's unit price is normally based on its net asset value, with holdings valued at mid-market or last traded prices. That figure ignores what it costs to trade. When the manager invests a large subscription or sells assets to meet a large redemption, the fund pays the bid-ask spread, brokerage commissions, transaction taxes and, for big trades, market impact. If the dealing investor transacts at the unadjusted price, those costs fall on everyone who remains in the fund. The gradual loss of value this causes is called dilution.
Dilution also creates an incentive to leave early. In a falling market, an investor who redeems first receives the full price while the cost of selling assets is left with those who stay, an effect described as a first-mover advantage. Regulators regard this as a possible source of runs on funds holding less liquid assets.
How it works
Each dealing day, once orders have been collected at the fund dealing cut-off, the administrator works out the net flow: subscriptions minus redemptions. If the fund has net inflows, the price is swung upwards so that buyers pay more; if it has net outflows, the price is swung downwards so that sellers receive less. The size of the adjustment, the swing factor, is an estimate of the cost of trading the underlying assets.
For example, a fund has an unswung price of 100.00 and a swing factor of 0.40 per cent. On a day of net subscriptions, all deals, purchases and sales alike, are struck at 100.40. On a day of net redemptions, all deals are struck at 99.60. The difference stays in the fund and offsets the trading costs. There are two main forms:
- Full swing pricing. The price is adjusted every dealing day in the direction of the net flow, however small.
- Partial swing pricing. The price is adjusted only when the net flow exceeds a set threshold, expressed as a percentage of the fund's assets.
Some funds use tiered factors that increase with the size of the flow. Swing factors are reviewed periodically by a committee of the management company and can be raised in stressed markets, within any maximum stated in the prospectus. The threshold is usually not disclosed, to prevent investors from timing their deals around it.
Operation and governance
The adjustment is applied as the last step of the net asset value calculation by the fund administrator, using flow data from the transfer agent's subscription processing and redemption processing. Timely and accurate flow data is essential, because the direction of the swing depends on it; a late or misreported order can lead to a wrong price and a NAV error correction. The policy is described in the prospectus, overseen by the fund's board, and its application is reviewed by the depositary and auditors as part of fund administration controls.
Advantages and drawbacks
Swing pricing allocates costs to those who cause them, protects long-term investors' returns and reduces the incentive to redeem ahead of others. It is simple for investors, since there is still one price per day.
It has costs. On a swing day, an investor dealing against the net flow benefits or loses by chance: a small buyer on a day of heavy redemptions buys at a reduced price. The published price becomes more volatile, and performance measured from swung prices can diverge from the benchmark for reasons unrelated to the manager's decisions, so many firms report performance on an unswung basis as well. The swing factor is an estimate, and in a market crisis the actual costs may exceed it.
Regulatory position
European supervisors have encouraged the use of swing pricing and comparable tools as part of fund liquidity risk management, and revisions to the EU's fund directives require managers to select liquidity management tools from a prescribed list that includes it. International bodies responsible for financial stability and securities regulation issued guidance in 2023 calling for wider and more consistent use of anti-dilution tools by open-ended funds.
In the United States, the securities regulator has permitted swing pricing for mutual funds since 2018, but it has scarcely been adopted. Funds there typically receive order information from intermediaries after the price has been struck, which makes it difficult to know the day's net flow in time. A 2022 proposal to make swing pricing mandatory met strong industry opposition and was not adopted.