Intra-day pricing helps managed funds deal with ETF threat

The Baltimore Sun

It's been a longstanding complaint of some mutual fund investors: Try to bail out at the start of a day when the market is cratering, and you'll find you're strapped in until trading ends, when the fund company prices the fund and makes all transactions for the day.

That may be changing.

Rydex Investments, of Rockville, Md., has priced its mutual funds twice a day for about the last six years, but the intra-day pricing was only available for customers making trades directly with Rydex. Last week, Rydex announced that it will be offering twice-a-day pricing to brokerage customers, a move that will expose many more fund investors to intra-day fund prices.

The question for many industry watchers is whether intra-day pricing will become more common as the mutual fund world steps up competition with exchange-traded funds.

The timing of Rydex's move is curious because it occurs just months after Fidelity Investments gave up on hourly pricing for its Select sector funds, noting that the more regular pricing option was not a big feature for investors.

The story is a big deal, however, because of the emergence of exchange-traded funds, which essentially are index funds that trade like stocks, allowing moment-by-moment pricing.

ETFs, effectively, are built to be trading vehicles, where a matter of moments or hours may make a big difference on the results of pursuing a short-term tactical allocation strategy. Mutual funds, traditionally, have been long-term vehicles, where a few hours in limbo becomes inconsequential for an investor who holds the fund for years or decades.

The primary perceived advantages for ETFs have always been low costs and the ability to trade like a stock, along with some secondary tax considerations. The ETF industry has been working to develop actively managed ETFs, which effectively would be like a traditional, managed mutual fund except trading on the exchange platform.

Here's where intra-day pricing might come into play.

Rydex, for example, offers both funds and ETFs that are built to be trading vehicles.

Kevin McGovern, managing director of mutual funds at the firm, noted that investors want the extra pricing points "because they know, for example, that program traders hit later in the day and the market can move significantly at that point, so having the ability to get out in the morning is almost like an insurance policy, allowing an investor to eliminate an unknown factor. ... But most mutual fund investors aren't that time-sensitive with the way they get into and out of the average fund."

Fund firms have a different reason to be interested in intra-day pricing, namely that it might stave off ETFs, especially if the Securities and Exchange Commission acts to allow actively managed ETFs.

One common worry for fund managers is the potential for a competitor to make a cheaper, generic version of their best products. If the ABC Focused fund routinely has 25 stocks and carries an expense ratio of 1 percent, for example, a shrewd manager could use the fund's disclosures and computer analysis of its price changes to create the XYZ Focused ETF, mimicking the established fund's strategy at about half the cost.

By pricing their flagship funds twice a day, the fund companies make it harder for competitors to get a foot in the door.

"Traditional fund managers are concerned about how actively managed ETFs could come in with a competitive edge," says Geoff Bobroff of Bobroff Consulting in East Greenwich, R.I. "Pricing more often is one way fund firms could respond, trying to keep the ETFs at bay."

That said, more regular pricing comes at a cost and may not solve the problem. Higher costs would give the copycat ETF a bigger cost edge, which would appeal to investors looking to get the same kind of portfolio on the cheap.

Insiders at Fidelity acknowledge that shareholder trading in sector funds was roughly the same as in its other funds. In other words, over years of having hourly pricing available - raising costs slightly in the process - sector-fund investors acted like average buy-and-holders, for whom an hour or two didn't make much difference.

In the end, intra-day trading will likely become the norm for funds built for market-timers, competing with ETFs that track similar benchmarks. This will give timers and tactical allocation investors more and better options. Intra-day pricing on actively managed funds is still a long way off, and most likely won't happen until the ETF business evolves further and includes actively-managed funds.

Charles Jaffe is senior columnist for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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