Moving to Daily Unit Pricing – Is it the right way to go?

Over the past few years there has been a steady trajectory for Funds to move towards daily unit pricing. That is, to calculate the value of Fund assets on a daily basis and then to apply this to the ‘price’ of member applications and withdrawals.


The argument for this approach has been that this is the most equitable way to treat investors, insofar that it represents the most ‘accurate’ view of the true value of the Fund at the point of transaction and prevents issues such as arbitrage or inequity between investors. However, there has been remarkably limited commentary around whether this approach, is in fact, the best way to go. Our view is that for many Funds moving to a daily unit pricing approach not only introduces excessive operational complexity but, in fact, it may not be the fairest way to treat investors.

Problem #1 – Dealing with market volatility

On the face of it, applying daily pricing in times of high volatility is the most equitable method. When an investor lodges their transaction request, their interest is valued based on the market value of assets at that time. What could be fairer than that? However, the flaw in this approach is that it assumes that the Fund can transact in the market at that same time to either buy assets to invest new money or to sell them to fund redemptions. In most cases it will take at least a few days for the Fund to transact on the cash flows generated by incoming and outgoing investors and, in a time of significant market volatility, this will often be at a very different price than that used to calculate the Funds unit price.

For example, assume that an investor submits a redemption request in an International fund on day T. The price offered to the investor will be based on the value of assets at the close of business on T. In order to ‘fund’ the redemption, the Fund is required to sell assets but this does not occur for a few days. In the intervening period, the market drops 3% (or more) and so the Fund is forced to sell assets at a discount, adversely impacting other members.

In many ‘real world’ circumstances it may take up to a week for an administrator to report cash flows to the Fund and then, at least a few days for the Fund to transact in the market. Given this, offering a ‘Daily’ price to the investor at the time of their transaction request presents an unrealistic assessment of when the Fund can reasonably transact on this information.

Problem #2 – Managing information ‘lag’

By calculating a unit price on a daily basis it assumes that the Fund has all the necessary information to accurately value the assets of the Fund on a daily basis. However, often this is not the case, particularly as the Fund invests in offshore and/or illiquid assets. For example, where a Fund holds assets in the United States, in order to accurately calculate the Unit Price not only should it reflect the closing price of the US markets but also should include the impact of any transactions for the day. Whilst many unit pricing processes are adapted to capture the latest market prices, it is unlikely that all transactions will be captured, particularly where these have been delegated to an external manager. If this is done, the delay in collating all relevant transaction data is often a week.

Further, there are often delays in valuing other assets such as derivatives and alternative investments due to the use of ‘over the counter’ third party intermediaries.

Problem #3 – Estimating Tax

By adopting a daily unit pricing process there is insufficient time to complete a full calculation of income tax accruals and the common practice adopted is to apply an estimated effective tax rate percentage based on the change in market values. For example, assuming a tax rate of 15%, the income tax accrual will be adjusted upwards by $150 for every $1,000 change in market value.

However, this approach can often lead to inaccurate tax accruals, particularly if no regular process is in place. Typical issues encountered include:

Failure to consider the impact of imputation and other tax credits in the determination of the ‘average’ rate, particularly where there is a reduction in tax accrual due to negative market movements
Deferred tax assets capping impacting the tax accrual, particularly where significant income is received by the Fund, such as a unit trust distribution
Properly estimating tax accruals is a complex matter and requires time and, often, matters of judgement. Recalculating this on a daily basis requires a significant simplification of the process and often overlooks complex issues that can lead to inaccurate calculations.

The arguments for adopting daily unit pricing at first seems sensible. If we are allowing members to transact on a daily basis, shouldn’t we be pricing it daily so that get the ‘correct’ price?

However, when considered in the light of practical reality we believe there are serious flaws in this logic as it assumes a level of perfection in both operational processes and access to information that is far from being achieved. If we then overlay equity considerations for long term investors wanting to participate in global diversified investment markets, then a longer time frame for pricing may in fact provide the best approach.

Bruce Russell, Director
Martin Walsh, Associate

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