AJ Bell Funds – Dilution policy and move to swing pricing

From the 6 January 2020, AJ Bell’s investment funds will move to a model of swing pricing in order to manage the effects of dilution. This article looks at what swing pricing and dilution are, and how our changes will affect your investment in the AJ Bell Funds.

What is ‘dilution’?

As part of the everyday operation of a fund, the investment manager will make purchases or sales of the fund’s underlying securities. These trades incur various costs – for example, commissions paid to brokers and transaction taxes. Investors who buy into or sell out of a fund bring about the need for the investment manager to make these purchases or sales; underlying assets may need to be bought in order to bring the fund’s asset allocation in line with its investment objectives, or may need to be sold to realise proceeds to meet investor redemptions.

The costs incurred through this trading impact overall performance and therefore have a tangible effect on returns for holders of the fund, an effect which is known as ‘dilution’.

To mitigate the effects of dilution and protect the returns of investors, fund managers use a variety of approaches, such as those discussed below.

  • Dilution levy: This levy works as an ad hoc charge which is applied to individual orders, generally those that are above a pre-set threshold. For example, a fund may place a dilution levy on orders that are greater than 3% of the fund’s overall net asset value. This acts to protect investors from the large transaction costs brought about by substantial individual orders. The dilution levy is a charge applied separately from a fund’s price.
    Although this method protects existing investors in the fund, it only captures specific large orders. So it is possible that on a particular day, the aggregate of several smaller orders could be greater than the dilution threshold; although these orders would still incur significant trading costs, they would not be subject to a dilution levy.
  • Pre-set dilution levy: Rather than only applying a dilution levy to individual orders, some funds will apply a pre-set charge on every investor purchase or sale. This does negate the effects of dilution, and could be seen as a fair approach as every investor will pay the levy rather than only those with larger orders, however the calculation of dilution on many individual orders introduces significant extra administration and operational difficulties. Some platforms do not have the required systems in place to cater for pre-set dilution levies.
  • Dual pricing: With this model, a fund will operate with two distinct prices: a) a bid price, at which existing holders are able to sell units; and b) an offer price, at which new investors are able to buy units, with the spread between the prices accounting for the dilutive effects of trading costs. A dual-pricing approach does address the problems of dilution, but the presence of two prices for the same fund introduces some complexity for investors. Some fund managers may also retain the difference between the bid and offer prices (known as the bid-offer spread) as a profit rather than paying the proceeds back into the fund, leading to issues of transparency.

The final commonly used anti-dilution mechanism, and the one chosen by AJ Bell Investments for its fund range, is swing pricing.

What is swing pricing?

As with the other methods discussed above, swing pricing aims to minimise the effects of dilution on existing holders by ensuring that those investors trading in or out of a fund bear their fair share of the trading costs that their orders incur. At a high level, swing pricing means that the fund’s daily price is adjusted upwards or downwards, depending on whether the day’s net inflows are positive or negative respectively, as illustrated below.

  • On Monday, there are net inflows into a fund. The price is therefore swung upwards by the dealing costs associated with the fund manager’s trading; this means that the entrants into the fund will pay for the purchases that the manager needs to make.
  • On Tuesday, there are net outflows from a fund. The price is therefore swung downwards by the amount of the dealing costs associated with the fund manager’s trading; this means that leavers from the fund will pay for the sales that the manager needs to make.

How does this change affect the AJ Bell Funds?

Currently, the AJ Bell Funds operate with a dilution levy. From 6 January 2020, we will be moving to a framework of swing pricing, where all transactions will be subject to a dilution adjustment, based on a daily swing in the fund prices. The new model will result in a fairer overall treatment for investors, compared with the old model, where only larger transactions were subject to dilution adjustments.

The dilution adjustment via the swing will be contained within the fund’s price and will not be an additional charge for investors; as such, no further items will be displayed on contract notes. AJ Bell Investments does not benefit in any way from the move to swing pricing; the benefits will solely be for the underlying investors in our funds.

By how much will the fund price swing?

The amount of the swing will be dynamic, based on an estimate of the transaction costs associated with the underlying instruments. However, we would estimate that the range of dilution will typically fall between 0.01% and 0.15% when buying or selling shares, with a maximum of 0.25% expected.

This amount will be subject to regular review to ensure that it continues to fairly represent the costs of trading.

Importantly, this change will not fundamentally alter the way in which AJ Bell Investments manages your fund; we believe that it treats all investors fairly, and protect the interests of our long-term holders.

Head of Operations, AJ Bell Investments
Mark studied Economics at Liverpool University, and has a master’s degree in International Banking & Finance from Liverpool John Moores University. Qualified to CISI Diploma level in Investment Operations, Mark came to AJ Bell with nine years’ experience in operations at a custodian and an investment management firm.