Pricing, valuation, dilution and dealing-point mechanics
Pricing questions test NAV mechanics, the dealing point and dilution - the area where small misunderstandings produce large mark losses.
Valuation point and dealing point
The valuation point is when assets are priced; the dealing point (cut-off) is when orders stop being accepted for that price. Forward pricing means the investor receives the price struck after the order. Assets are valued at bid, offer or mid depending on the pricing basis: single-priced funds typically use mid with a dilution adjustment, while dual-priced funds use bid for redemptions and offer for subscriptions, the difference being the spread.
Dilution
When a fund deals, the portfolio must be bought or sold, incurring dealing costs and spread. Two mechanisms protect continuing investors:
- Dilution levy: a separate charge added to subscription monies or deducted from redemption proceeds, paid into the fund.
- Swing pricing: NAV per share is swung up on net inflows or down on net outflows by a dilution factor once a threshold is crossed.
Pricing errors
Prospectuses and local regimes set a materiality threshold, commonly 0.5% of NAV and sometimes 0.1%, above which the fund compensates affected investors and notifies them. Below the threshold the error is logged and monitored. Repricing and compensation must be documented and subject to independent review.
Worked example
A fund has NAV per share of 100.00 and applies a 2% swing on net outflows above 1% of NAV. Net redemptions are 3% of NAV, so the swung NAV is 100.00 × (1 − 0.02) = 98.00. Redeeming investors receive 98.00, so remaining investors are not diluted by the dealing costs. With a 2% dilution levy instead, the deduction would come off proceeds and be paid into the fund's assets.
Traps
- Confusing a dilution levy (paid into the fund) with an initial charge (paid to the distributor).
- Assuming swing pricing applies on every deal regardless of thresholds.
- Mixing up the valuation point with the dealing cut-off.
- Treating a sub-threshold error as requiring no record at all.