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Proposed SEC Rules Could Change How You Invest


The Securities and Exchange Commission has proposed several rules aimed at ensuring the liquidity of open-end funds, especially if there is a financial crisis. The SEC’s proposals would oblige fund managers to adopt specific liquidity risk management measures, including having most open-end funds adopt “swing pricing” and keeping at least 10% of their assets liquid. The proposals are controversial, both because of the rationale for the measures and for the effect it will have on retail investors as well as mutual fund sponsors.

Consider working with a financial advisor as you seek funds for the liquid portion of your investment portfolio.

What Are Open-End Funds?

When you buy a mutual fund, you’re buying shares in that fund. An open-end fund has no limit on the number of shares it can issue. So, when you purchase your shares, more shares are created. If you sell your shares, the open-end fund buys them back. Open-end fund shares are purchased at what’s known as their net asset value or NAV. This number reflects the total market value of the assets held in the fund at the end of each trading day, less liabilities and divided by the total number of outstanding fund shares.

Market value of the fund’s underlying assets is calculated daily at the end of trading. So, if the fund includes a mix of stocks and bonds, the final closing price of the individual stock and bond holdings can be used to tally up the fund’s market value. This means the fund’s NAV can change daily as stock market prices fluctuate during trading hours. Essentially, NAV reflects how a fund performs on any given day.

Examples of open-end funds include traditional mutual funds, hedge funds and exchange-traded funds (ETFs), which are funds that trade on an exchange like a stock. You can buy and sell these kinds of funds in an employer-sponsored retirement plan, such as a 401(k), in an individual retirement account or through a taxable brokerage account.

A Possible Problem

SmartAsset: Proposed SEC Rules Could Change How You Invest

Open-end funds can become problematic if investors sell off a large number of fund shares all at once, as they did during the pandemic when investors sold more than $100 billion high-yield bond mutual funds and investment-grade corporate bonds. That forced funds to sell holdings to pay departing investors.

“This led the Federal Reserve to intervene by offering, for the first time, to buy corporate bonds and exchange traded corporate bond funds in what proved a successful effort to keep credit to corporations flowing,” according to Brookings. “It was an extraordinary move that underscores the risks these funds pose to financial stability.”

SEC’s Proposals

Among the commission’s responses to the perceived need for greater liquidity – so the Fed won’t have to engage in extraordinary measures to protect the financial system’s viability – are three initiatives that concern the operations of open-end funds:

  • Swing pricing. This would allow managers to lower their funds’ net asset value in response to heavy redemptions. The reason they would do so is because a wave of selling would force managers to unload illiquid assets to pay departing investors. With swing pricing managers could shift the cost to investors who are selling. That, in turn, could disincentivize investors from selling since they would not be protected from the resulting costs.
  • Hard  close. Currently a fund manager must calculate a fund’s NAV using orders sent by investors to a qualified intermediary no later than the close of trading, typically 4 p.m. ET. A hard close, however, would require a manager to calculate a fund’s NAV using orders actually received by 4 p.m. – not sent by 4 p.m.  And that would make it much simpler for fund managers to implement swing pricing.
  • Liquidity of 10%. The SEC proposes to mandate that open-end funds maintain at least 10% of balances in liquid assets.

How It Could Affect You

SmartAsset: Proposed SEC Rules Could Change How You Invest

If after the 60-day comment period the SEC proposals are implemented, retail investors will need to be aware that selling out of an open-end fund may entail as-yet unknown expenses (because of swing pricing). Also, the proposals could end same-day settlement and net-asset-value strikes per day. It also could hit retirees.

“The SEC’s swing pricing proposal could have an enormous negative impact on the more than 100 million Americans who invest in funds, especially retirement savers,” according to the Investment Company Institute. Fully “63 percent of 401(k) plan assets are held in mutual funds, and these plans will be severely harmed by the SEC’s proposed ‘hard close,’ which is likely to make it impossible for 401(k) plans to place trade orders for their participants.”

On the other hand, assuming the SEC’s rationale for the proposals is correct, the overall soundness of the financial system would be improved and better able to withstand a crisis.

“A defining feature of open-end funds is the ability for shareholders to redeem their shares daily, in both normal times and times of stress,” said SEC Chair Gary Gensler. “Open-end funds, though, have an underlying structural liquidity mismatch. This can raise issues for investor protection, our capital markets, and the broader economy. We saw such systemic issues during the onset of the COVID-19 pandemic, when many investors sought to redeem their investments from open-end funds. Today’s proposal addresses these investor protection and resiliency challenges.”

Bottom Line

The SEC aims to make investors in open-end funds bear the costs of net redemptions. It proposes to do so by mandating swing pricing, hard close at the end of each trading day and requiring funds keep at least 10% of their assets in liquid form.

Tips on Investing

  • A financial advisor can offer valuable insight and guidance as you look for a place to hold liquid assets while minimizing the potential for a loss. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Use SmartAsset’s free investment calculator to get a quick estimate of how your investments will do over time.

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