The markets regulator has floated the concept of swing pricing in debt mutual funds, which would kick in at times of high stress. Essentially, this would increase the cost of exiting schemes, discouraging large investors from sudden redemptions. Mint examines it in detail:
What is the concept of swing pricing?
A Securities and Exchange Board of India (Sebi) consultation paper on 19 July floated the concept of swing pricing for open-ended debt mutual funds. Essentially, at times of market stress, the scheme’s exiting investors will get a lower net asset value (NAV). According to Sebi, swing pricing will be optional during normal times, but compulsory during so-called market dislocation. During such dislocation, full swing will kick in imposing costs on exiting investors, regardless of the size of redemptions. In normal times, partial swing will be imposed that will only kick in if flows exceed specified thresholds.
How does swing pricing help?
When large outflows happen during the times of market stress, the fund manager is forced to sell high-quality and liquid papers to meet redemptions. This leaves other investors with a portfolio of lower-quality and illiquid papers. Thus, investors staying put have to bear the brunt of subsequent defaults. Sebi has introduced other rules as well to mitigate this effect, like a mandatory allocation to cash or equivalents and separation of bad debt into segregated portfolios (side-pocketing). Swing pricing will supplement such measures. Swing pricing can dissuade large or savvy investors from exiting the fund in times of market panic.
When and how will swing pricing take effect?
Sebi will first determine whether a ‘market dislocation’ is underway. It will do so either on the recommendation of the Association of Mutual Funds in India or a combination of factors like net redemption build-up at the industry level and market indicators. Once a market dislocation is declared, high-risk debt mutual funds will have to mandatorily impose swing pricing.
How much will swing pricing affect NAV?
Each fund house must specify the extent of swing pricing that will be imposed. But Sebi has proposed a minimum swing pricing for high-risk mutual funds. For instance, schemes falling in the C-III category, which have maximum credit risk and maximum duration risk, will have a minimum 2% swing. In other words, in times of distress, redeeming investors will have to take a 2% lower NAV. While the regulator has not introduced swing pricing for equity and hybrid funds, the paper says Sebi will examine the features for them also.
Are there safeguards for retail investors?
Yes; redemptions up to ₹2 lakh for individuals and ₹5 lakh for senior citizens will not be hit by swing pricing. Also note that swing pricing is mandatory only in times of market distress. In normal times, swing pricing is at the discretion of the fund house, and the way in which it will be imposed and the extent to which it will be imposed will have to be mentioned by the fund house in the Scheme Information Document. If you do not agree with the swing pricing feature, you can always avoid such funds.
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