Swing pricing “has become common market practice” in the Luxembourg fund sector to manage liquidity at times of volatility in the market, according to a recent industry survey by the Association of Luxembourg Fund Industry, or Alfi.
Swing pricing is a liquidity management tool used to assign the costs of a redemption to shareholders whose orders caused the trades. It is designed so that remaining shareholders don’t bear all the costs caused by first movers. This technique emerged in the late 2000s, came to wider attention after the global financial crisis, with its relevance affirmed during the Covid and Ukraine crises.
Of the 56 managers surveyed for the 2022 Alfi Swing Pricing Survey, 45 said they apply swing pricing. The survey showed that swing pricing is applied by funds managing 65 percent of the total funds under management in Luxembourg, compared to 53 percent in the 2015 survey.
Asset managers representing 20 percent of AUM do not use this technique. Around 80 percent of those who use swing pricing have done so for more than five years on their Luxembourg fund range.
Mechanism prevents loyalty from being penalised
When fund investors redeem their holdings, this can generate a cost, particularly during periods of market correction when liquidity is scarce such as during the March-April 2020 market sell-offs at the beginning of the Covid pandemic. Without swing pricing, the costs are borne by those investors who stay loyal to the fund. Given that fund investment is designed to be a long term commitment, asset managers have turned to swing pricing to help prevent loyalty being penalised.
Thus, when certain circumstances are met, a fee - known as a “swing factor” - will be charged to the departing investor. Funds can either operate a “full swing” policy, in which factors are applied in all circumstances, but more usually they use a “partial swing”, which is implemented after a pre-defined capital activity threshold is reached.
Maturing technique
As would be expected, Alfi is upbeat to note that “asset managers in Luxembourg have matured swing pricing techniques, implementing experience over market cycles and developing system capabilities.” Its survey encompassed 56 of the leading asset managers in Luxembourg who between them covered nearly three quarters of total assets under management. The results were published alongside revised Alfi Swing pricing guidelines.
Swing pricing has become commonplace since the last survey in 2015, most notably in France, Spain and most recently Germany. However, in the US and Asia-Pacific it is “not commonly applied” but “regulators and industry bodies continue to explore the potential benefits,” according to the report.
Partial swing most common
The “partial” swing method is the dominant approach, as it was in the 2011 and 2015 surveys, yet it is less widely used for alternative funds than for Ucits funds. For the managers of Ucits equity funds, full swing was used by about 10 percent, with most of the rest using partial swing. Of the 35 managers offering fixed income strategies, one applied no swing, three full swing and 30 partial. Those which didn’t use swing pricing techniques said this was due to fund or client specific factors.
Some 27 managers of alternative funds were surveyed, of which there was a 60/40 split between those offering no swing and partial swing, with none choosing to use full swing. A lack of liquidity is at the centre of the reluctance/difficulty of using this technique, as was the closed-end nature of many of these products which restricts the ability of investors to exit the fund. No private equity or debt funds used swing pricing, with only one out of 12 real estate funds doing so.
What swing factor
The swing factor is normally a percentage by which the fund net asset value is adjusted when the redemption is made under swing pricing. In the survey these varied by asset class with equity, fixed income and multi-asset funds most commonly capped between 2-2.5 percent. This is consistent with the 2 percent which was observed in previous surveys. Fund of fund products, real estate and other alternative funds typically have a lower maximum factor closer to 1 percent.
The survey also looked into how thresholds and swing factors are calculated. Bid-offer spread impacts, transaction costs and transaction taxes associated are all components that influence managers’ policies. Almost all of those surveyed use all three of these components in their methodology.
These policies have matured over the years, with each market crisis enabling players to test and refine their models. Under normal market conditions, over half of asset managers (60 percent) continue to review and re-calculate swing factors on a quarterly basis. A quarter do this on a monthly basis, with a handful doing this weekly. At the extremes, some review daily, others annually. During the market volatility experienced in March and April of 2020, over two thirds of asset managers surveyed performed a daily review of swing factors at some point. Three quarters have standalone committees for reviewing swing factors.