In September 2021, markets regulator SEBI introduced a swing pricing framework to protect the value of holdings of small investors in debt mutual funds that faced high redemption pressures.
Broadly speaking, when a fund faces a high pressure of redemption from a number of investors, this new pricing model of debt mutual funds will come into force. Under this, the asset management company (AMC) will rework the NAV (net asset value) for those exiting or entering the fund. This new NAV will be priced lower than the actual NAV.
Redemption of debt funds
Those who are selling their units in debt mutual funds will be allowed to exit at the newly adjusted NAV. Similarly, those entering the fund will be able to enter at a lower price. As a result, the investors who remained invested in the fund will not have to bear the brunt in terms of lower returns — a likely upshot of redemption.
Imagine a scenario where the swing pricing mechanism is not in force. There are multiple costs such as trading costs, the cost of borrowing to meet redemptions and the price impact of executing large trades. Collectively, they eat into the scheme returns.
Usually, the better quality and liquid securities are sold first, and the remaining investors might be left with lower returns and illiquid securities. So, swing pricing framework will try to solve this problem of lower returns for the “left out” investors.
The plan ahead
The new framework will be rolled out in March 2022. There will be two kinds of swing pricing – partial and full swing. The partial swing will be introduced in normal market conditions where AMC can introduce an adjusted NAV once the total outflows cross a certain threshold.
However, in case of extreme market situations, full swing pricing could be announced on high risk open-ended debt schemes for a limited period.
Much to the relief of small investors, redemptions of up to ₹2 lakh are exempted from the swing pricing mechanism.
So, we can summarise that the swing pricing mechanism is an attempt to protect the interest of investors who remain invested in a debt fund even after significant redemptions take place. This will be done by letting the investors to redeem their units at an adjusted NAV, which would be lower than the actual NAV.