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SEBI proposes swing pricing mechanism to tackle NAV erosion in mutual funds

25 January 20235 mins read by Angel One
SEBI proposes swing pricing mechanism to tackle NAV erosion in mutual funds
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The Securities and Exchange Board of India has proposed a swing pricing mechanism to check the fall of net asset value (NAV) of a scheme in case of investor exodus.

This mechanism will enable fund houses to adjust the NAV of a scheme in situations like inflows or outflows from a fund, specifically during market dislocation. It will effectively prevent value erosion during heavy redemptions.

Why this reform now?

Franklin Templeton, India’s 8th largest mutual fund house, voluntarily winded up 6 fixed-income schemes last year. These 6 funds comprised around Rs. 25,000 crores in assets.

Such a drastic step puzzled many of the investors and trade analysts alike. However, Franklin Templeton cited massive market dislocation and illiquidity due to the pandemic as major factors responsible for the decision.

SEBI’s proposal to introduce swing pricing is part of various reforms that the body is taking in the backdrop of the Franklin Templeton incident of April 2020.

Experts state that swing pricing is a potentially effective risk-mitigating mechanism for products with high liquidity risks.

A close look into the matter

SEBI states on its website that during the market dislocation, it will apply a minimum stipulated swing factor, which will be risk-based. However, an AMC has the liberty to levy a higher swing factor if it believes that would be in the best interest of its unitholders.

A minimum 1-2% swing factor has been proposed by SEBI for open-ended debt schemes.

What is the swing factor?

The swing factor is the amount that exiting and entering investors need to incur and pay, respectively. It is implemented when a specific level of net inflow or outflow is realised in a fund.

The mechanism often prevents large investors from pulling out from a scheme in haste. It is calculated as a percentage of the total holding of an investor in a fund. Both entering and exiting investors will have the net asset value adjusted for swing pricing when the swing factor is applied.

To make this easier to understand, let’s take an example. Suppose a fund’s NAV is Rs. 50 with a swing factor of 0.1%, which will come into effect if a net flow of 15% is realised. Thus, its NAV will be adjusted upward or downward to Rs. 50.05 or Rs. 49.95 in the case of a net cash inflow and outflow of 15%, respectively.

Is there any drawback?

Some financial experts believe that swing pricing can discourage corporates from investing in small debt funds. This is because the optimal limit of swing pricing in such situations would be lower. For instance, a 5% threshold in an Rs. 100 crore-fund would stand at Rs. 5 crores. Moreover, there might be cases of corporates trying to manipulate the system using swing pricing for desired outcomes.

Final words

The government has decided to implement a swing pricing mechanism in phases. In the first phase, swing pricing will be applied only during outflow market dislocation. In the following phases, SEBI intends to apply the swing pricing mechanism on equity schemes, index funds, exchange-traded funds, solution-oriented schemes, and more.

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Frequently Asked Questions

  1. Is there any exemption for small investors from the swing pricing mechanism?

Small investors are eligible for exemption of up to Rs. 2 lakhs.

  1. What is the exemption for senior citizens?

Up to Rs. 5 lakhs

  1. What are the benefits of the swing pricing mechanism during market dislocation?

Better transparency, predictability, and effectiveness of the mechanism

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