A hallmark of the $18 trillion mutual-fund industry is that it promises easy entry and exit for investors. U.S. regulators now want new protections to ensure that pledge can be met, due to concerns that firms have loaded up on hard-to-sell assets.
The five-member Securities and Exchange Commission (SEC) voted unanimously to pass a measure Tuesday that addresses criticisms that its rules haven't kept pace with the evolution of the fund industry. The SEC's proposal follows warnings from the Federal Reserve and International Monetary Fund (IMF) that some funds could struggle to meet investor redemptions during a market rout.
Under the proposal, funds would have to maintain a minimum cushion of cash or cash-like investments that can be sold within three days. Funds also could charge investors who pull their money on days of elevated withdrawals.
“Changes in the modern asset management industry call on us to now look anew at liquidity management in funds and propose reforms that will better protect investors and maintain market integrity,” SEC Chair Mary Jo White said.
Mutual funds, which are held by 53 percent of all U.S. households, already face a legal requirement to return cash to investors within seven days. In search of higher returns, many fixed-income funds have migrated into riskier debt that doesn't trade often and could be difficult to sell at fair value during a period of market stress.
A key concern is that any problems will be exacerbated when the Fed raises interest rates, causing bond prices to plunge and prompting fund investors to run for the exits.
The SEC's plan would force funds, including exchange traded funds (ETFs), to adopt liquidity-management plans and classify how long it would take to convert positions to cash. Funds would have to hold a minimum amount of cash or cash equivalents, meaning the assets could be sold within three days. A fund's board of directors would decide what percentage of a portfolio must be easily liquidated.
Swing Pricing in Mutual Funds
The recommendation also would give mutual funds the ability to use swing pricing, which would permit asset managers to pass on trading costs to investors who redeem. Under current rules, investors buy and sell shares at a mutual fund's closing price, known as net asset value (NAV).
Under swing pricing, exiting investors would receive a price that is slightly lower than a fund's NAV. Some SEC officials think the change could curb the impulse to stampede out of mutual funds when asset prices are at risk of tanking.
Current mutual-fund pricing rules harm investors who remain in a fund after a sell-off, according to a September 10 report by Barclays Plc.
Investors who sell their shares on days when a lot of cash leaves a fund get an inflated price because the least liquid holdings aren't immediately repriced, Barclays wrote. After a fund estimates the new price for those bonds, the fund's value declines, lowering returns for investors who still own shares, the bank's analysts wrote.
Investors also absorb trading costs that a fund incurs when it has to sell securities to meet redemptions, Barclays wrote.
“The benefit to early redeemers is effectively a tax on investors who remain invested through big downturns,” Barclays' analysts wrote.
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