Day 0, NAV 1,000, Units on Issue 1,000, Unit Price 1.00
Day 5, NAV 1,060, Units on Issue 1,000, Unit Price 1.06Underlying Fund
Day 0, NAV 1,000, Units on Issue 1,000, Unit Price 1.00
Day 5, NAV 1,060, Units on Issue 1,000, Unit Price 1.06
In this example we have a fund with issued units of 1,000 and a unit price that has steadily increased from inception at $1.00 to Day 5 at $1.06. The fund holds all the assets of the underlying fund; and the price has moved similarly.
Now continuing with the example say on Day 5 an investor lodged an application for $1,000. In this example it would take 4 days, Day 9, before those funds would be unitised in the underlying fund. The funds are unitised in the fund at $1.06 giving 943 units. The asset, the units in the underlying fund, are valued at the last available price, being $1.06. It is not until Day 10 that the funds are unitised and the investment confirmation is received detailing the actual unit received. At that time the valuation must be adjusted.
Day 5, NAV 1,060, Units on issue 1,000, Unit price 1.06
Day 6, NAV 2,060, Units on issue 1,943, Unit price, 1.06Day 10, NAV 2,100, Units on issue 1,943, Unit price 1.08
Underlying Fund
Day 5, NAV 1,060, Units on issue 1,000, Unit price 1.06
Day 6, NAV 1,060, Units on issue 1,000, Unit price, 1.06
Day 10, NAV 2,100, Units on issue 1,909, Unit price 1.10
As a result of the mis-match the existing unitholders have suffered a loss; and are therefore have not been treated equally.
To correct the situation the operator would need to compensate the fund to the tune of $37.74 - 1,943 units * (1.10 – 1.08).
Time to market issues exist because we operate in the real world. There are many fund structures that have 7 or more interfunding layers. These layers can be external (as in the case of Platforms) or internal or a combination of both. Depending on the systems being used each layer can take a day for the funds to flow through one layer of the structure. So 7 levels is 7 days for the funds to be actually invested.
Although 99% of the market is using forward pricing this does come with its issues. Just looking at a standard flow of funds:
- Daily cut-off for applications/redemptions: 3pm
- Processing completed: by 7pm
- Unit price calculated for prior day: 10am
- Cash availability to fund manager: 11am
However the units were issued based on the valuation for the prior day. The cash wasn’t invested until the next day, at best. Some fund managers have tried to avoid this by taking cash flow estimates at the end of the day and then taking futures or physical positions to cover any large flows overnight.
In most situations time to market will not be an issue as the funds flow will be a small proportion of the fund size however exceptions always exist (eg GFC).
The regulations provide little guidance on time to market issues. Section 10.8 of Standard 8 allows units to be issued prior to funds being received; but this really doesn’t help. You can use the standard 30 basis points and $20 compensation rules however most of us are now using much tighter tolerances.
There are now automated solutions for some of these issues where some unit registry systems allow cash to be flowed through the interfunding structure on the same day. However this solution only works for trusts within the same operator or using the same systems which still leave issues where one trust is investing in an external trust.
Unfortunately I don’t have any solution except to say:
- Be aware of the level of interfunding within your products and the associated time to market issues
- Of course the issue is impacted by size of cash flow in relation to fund size so look at having some safety checks within the process to monitor the cash flows.
- And then have a plan on what to do if the impact exceeds your thresholds.
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