Large Redemption, Dilution Levy and Swing Pricing
Global Small Cap Fund has NAV of USD 850 million, daily dealing with a 12:00 CET cut-off and forward pricing. On Tuesday an institutional investor submits a redemption for 18% of NAV at 11:58. The portfolio holds 7% cash and illiquid small-cap positions; selling to meet the redemption is expected to cost 1.4% of the redeemed amount and would dilute continuing investors. The prospectus permits the board to apply a dilution levy of up to 2% and also contains a swing-pricing policy with a 3%-of-NAV trigger and a 1.1% swing factor. The transfer agent's pricing team receives the instruction but the fund's operations manual is silent on whether the levy and swing price can be combined. Separately, at 12:05 another investor submits a large subscription, arguing the TA website showed a 13:00 cut-off because of a daylight-saving error. The board wants to protect remaining investors but is concerned about treating investors differently.
1. Explain how the dilution levy and swing pricing would each operate in this scenario and recommend which mechanism the fund should apply, with reasons.
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A dilution levy is a charge on the redeeming investor, deducted from redemption proceeds and credited to the fund, so continuing investors are compensated for dealing costs. Swing pricing adjusts the NAV per share used by all investors dealing at that valuation point, usually when net flows exceed a threshold; the 18% redemption is far above the 3% trigger. The 1.1% swing factor is intended to approximate dilution, but the estimated cost here is 1.4%, so the board should consider whether 1.1% is adequate or whether the levy is more precise. A fund cannot normally apply both a swing price and a dilution levy to the same deal unless the prospectus expressly permits cumulative application and this is disclosed; doing so could overcharge and breach fair-treatment principles. Read the prospectus and board policy: if swing pricing is the adopted anti-dilution mechanism, apply the swing factor to the NAV for the dealing point and disclose the adjusted price. If the board instead applies the levy, charge up to 2% to the redeemer only. The decision must be consistent, documented and applied to all deals at that dealing point, not just the large one. If the fund is unsure, escalate to the board or valuation committee before striking the NAV.
2. How should the 12:05 subscription be treated? Consider the dealing point, the website error and the fund's error-correction policy.
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The 12:00 cut-off is the dealing point; instructions received after it are normally held for the next dealing day and priced at that day's forward NAV. The website's erroneous 13:00 statement is an operational error, but it does not automatically vary the fund's prospectus. Investigate: preserve the website version, logs and the investor's submission timestamp; establish whether the investor actually relied on it. Under the fund's error-correction and complaints policy, the TA may offer a remedy if its own misleading communication caused loss, but any remedy must be fair, documented and approved, and should not give the late investor an advantage over investors who complied. The 12:05 subscription should be processed for the next dealing day unless the fund's documented error policy expressly allows late acceptance. Communicate promptly with the investor, log the complaint and report the incident. Do not backdate the instruction. The 11:58 redemption remains at the T price. If the website error affected multiple investors, treat it as a systemic incident and consider notifying the board and regulator as required.