Fair to middling: Mike Truman examines the problems of introducing single pricing

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The Independent Online
SINGLE PRICING has been a topic of debate in unit trust circles for most of the past decade, but scarcely anyone outside the industry knows what it entails. They might be more interested if they had a greater understanding of how unit trusts are priced at present .

To get to the price of a single unit in a trust you have to divide the value of the assets it holds by the number of units in issue. So if the shares the unit trust has invested in are worth pounds 10 million and there are 20 million units in the trust, each one is worth 50p. In practice the trust will have two prices, with a difference of about 5-7 per cent between them to cover costs and commission paid to advisers. This difference is known as the 'spread'.

The problem with pricing unit trusts comes from the different ways the assets can be 'valued'. If more money is coming into a trust than going out, the manager wants to make sure that investors coming in are not getting more than their fair share of the assets.

The offer price (the price the investors buy their units at) will therefore probably be set by reference to the full cost of purchasing the portfolio: the cost of the investments plus dealing charges and commission.

The bid price (which investors selling their units receive) will be set by deducting the spread from the offer price. This is known as pricing the fund on an 'offer basis'.

It is a different story if the trust is losing money, with more investors cashing in their units than buying new ones. The manager is then selling investments and needs to be sure that people cashing in are not getting more than their fair share. So the manager will tend to price the trust's assets as the cash that could be realised if the whole trust was liquidated, at selling prices less costs.

That will be the bid price. and the offer price is set by adding the spread to the bid price. This is known as pricing on a 'bid basis'.

These two methods of valuation broadly reflect the maximum and minimum prices at which a unit trust is allowed to deal. Managers may choose to set their prices anywhere between these two limits. Unfortunately the difference between the prices set by the two valuation methods is almost always more than the spread. That causes unit trust prices to be more volatile than the market they are investing in.

As a stockmarket rises, it sucks in new investors attracted by the returns. The excess of buyers over sellers means that the manager prices the fund on an offer basis. Suddenly the market takes a nosedive and investors stampede out of the trust. Faced with an excess of sellers over buyers, the manager switches his pricing to a bid basis, and the price falls 4 or 5 per cent overnight.

Single pricing aims to prevent this, and in particular to make the pricing structure clearer. The problem is finding a pricing scheme which achieves this while also ensuring that investors only get their fair share from a trust.

The Securities and Investments Board (SIB) wants to authorise new open-ended investment funds managed in the UK that can be sold in Europe. That requires a single pricing system, and the SIB issued a discussion paper a year ago.

The most obvious 'fixed' price is one that is set halfway between the bid and offer basis. This has the advantage of being simple, but it does nothing to counter the argument that those coming in when the trust is expanding get in cheap and those leaving as it contracts get out with more than they should. Proponents, however, argue that for most funds this argument is theoretical, and that in practice the effect is minimal.

At the other end of the spectrum is the 'full swinging single price'. Very close to the current system, the price would be on a full offer basis or a full bid basis, with the spread being taken off or added on respectively.

Although this solves the problem of fairness to investors, it only serves to aggravate the swing in price when the basis changes from offer to bid or back again. So the third option is the 'semi-swinging single price', which is a combination of the other two.

Normally the fund would be on a fixed price midway between offer and bid basis, but if the total transactions in any one day amount to a reduction or an increase in the value of the funds in the trust by more than 2 per cent, the price could be moved towards offer or bid as required. This system provides a fixed price for most of the time while dealing with the problem of large inflows or outflows of cash. But it must be remembered that the original aim was to simplify the pricing structure of unit trusts. Fair it may be, simple it is not.

It is, however, worth remembering that a fund that has a steady cashflow, perhaps because it is the basis of a major PEP provider's plans, is less likely to have substantial changes to its cashflow, and is therefore less likely to change the basis on which it is quoted.

(Photograph omitted)

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