Abstract

AbstractHow can fragility be averted in open-end mutual funds? In recent years, markets have observed an innovation that changed the way open-end funds are priced. Alternative pricing rules (known as swing pricing) adjust funds’ net asset values to pass on funds’ trading costs to transacting shareholders. Using unique data on investor-level transactions in U.K. corporate bond funds, we show that swing pricing eliminates the first-mover advantage arising from the traditional pricing rule and significantly reduces outflows during market stress. Swing pricing also reduces concavity in the flow-performance relationship and dilution in fund performance.

Highlights

  • How can fragility be averted in open-end mutual funds? In recent years, markets have observed an innovation that changed the way open-end funds are priced

  • We further ensure additional robustness to our main findings by including different fixed effects, front- and back-end loads, and alternative definitions of market stress based on TED spread, LIBOR rate, and Merrill Lynch’s MOVE index, all results reported in Table IA.2.22 We estimate the regression model for each fund style category separately, with results reported in Table IA.3.23 Results are similar across individual styles

  • While including fund controls or fund fixed effects in our regressions alleviates this problem to some extent, 22 We have estimated a model with an alternative measure of stress based on the 90th percentile of volatility index (VIX)

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Summary

Institutional Background

Fund investors have the right to transact their shares at their funds’ net asset values (NAV). Alternative pricing rules have emerged to allow open-end mutual funds to adjust their NAVs to reflect such costs. We do not observe any switches from alternative to traditional pricing scheme during our sample period These patterns arguably suggest that the market favors swing pricing, but the market might be in a transition phase whereby market participants are gradually learning of its promise. We define of the following variables: Flow is the monthly change in a fund’s quantity of shares outstanding multiplied by the share price, divided by the fund’s TNA Both the numerator and the denominator are measured as of time t to prevent a potential contamination in Flow due to fund price adjustment. If this price is missing, we use the prices provided by iBOXX or ICMA

Fund switching dates
Empirical Results
Fund flows and alternative pricing
Quantile regressions
Using end investor flows for switchers and their matched funds
Proportion of alternative funds and fund flows
Do fund companies substitute away from other risk management tools?
Conclusion
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